Investment Questions, Misconceptions and Traps

From 8 a.m. until 5 p.m. (OK, OK … more like 4:30 p.m., especially in the summer) every weekday, my job consists of giving good investment advice in a clear and timely manner.  But in this Cabot Wealth Advisory, I wanted to start with a brief question of my own, and see if some readers out there can help me find an answer.

Here it is:  How much of a possibility is it that General Motors will not only go bankrupt, but actually cut some of the benefits it gives to retirees?  The reason I ask is family:  My father-in-law was a lifelong GM employee, and got out a few years ago after hitting a good retirement age.  He’s now working at a another job, but seeing GM stock heading straight down of late, I wonder if his (or any other GM retiree’s) pension is at risk.

My guess is no, simply because, even if the company filed for Chapter 11, which itself isn’t a high odds outcome, that the politicians wouldn’t allow older people (read: voters) to see their monthly income slashed by 20%, 30% or more.

But then again, I really have no idea–I’m just a student of the stock market, not a student of corporate and economic history.  So if you have some hard evidence about huge company pensions that have been canceled or reduced before, and under what circumstances, shoot me an email.  And if you’ve got an opinion on GM’s future, let me have it.  I’ll share the best contributions in a future Cabot Wealth Advisory.

Common Market Misconceptions

Now I want to touch on a couple of common market misconceptions, beginning with a question I received from a subscriber just the other day.

Question: Why are you not also focusing on beaten down stocks like GM, GE, the banks and brokerage stocks, Motorola, etc.?  When the market finally turns, clearly many of these blue chip stocks will be the leaders and offer the best immediate gains.  Yet the Cabot Market Letter ignores them completely and appears to chase momentum stocks.

The answer is simple-as a growth stock investor, I don’t focus on those beaten-down blue chips because they won’t be the leaders of the next bull market.  The reasoning behind that is a bit tougher to understand.

The market, remember, is a contrary animal, so while 95% of investors are always hunting for a bargain, the best stocks come off their launching pads after already having outperformed the market for many months.  This is not my opinion; it’s a historical fact.

Keep Your Eyes on the Prize

No matter how often I write this, or tell people this, few believe it or embrace it.  But I’ve found that accepting it is incredibly liberating–never again do you have to try to pick bottoms, or worry about missing the boat.  And thus, you never have to be smart and buy blue chips on the cheap.

In this particular case, of course, when a new bull market begins, the stocks my correspondent mentioned will likely spurt higher initially–the most beaten-down stocks usually do.  However, to make money from that spurt, first you’re going to have to get in near the bottom; many investors thought Merrill Lynch, General Electric, Citigroup and their ilk were near a bottom months ago, but these stocks have continued to sink to new lows.

More important, even if you do pick the bottom, and even if you do get the benefit of the initial thrust off the lows … then what?  Our experience is that it pays to start fresh and look for the leaders of the next advance–those stocks that can double, triple and quadruple and attract billion of dollars of institutional money.

In other words, even though the market is in the dumps right now, one of your jobs as a profit-seeking investor is to keep your eyes on the prize.  That is, you should always remember the BIG money that can be made in a new bull market.  I’m not just selling sunshine here; you can seriously see your portfolio rise 10% to 20%, conservatively, in the beginning months of a bull market.  And then the gains pile on from there.

But you’re only going to see that happen if you’re focused on the right stocks, and–as I wrote two weeks ago–if you don’t stick your head in the sand.  Bottom line:  Ignore those old, beaten-down leaders that look cheap, and instead, keep your watch list fresh with new, revolutionary companies that are growing sales and earnings at a brisk pace.

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Really, everything we do here at Cabot comes down to one basic principle–trying to make money by using knowledge of how the market actually works.  Most people think they know how the market works, or how it should work. They study academic theories, or hold on to beliefs of certain causes and effects (i.e., earnings will rise, so the stock should go up).

I believe this is our biggest advantage compared with other advisors; I’ve already made every mistake in the book (and continue to find new ones), but I’ve learned enough to understand that the way the market works, and the way people think it works, are vastly different.

A Bearish Change in the Commodities Stocks

For instance, my experience and studies tell me that when a hot group that’s been running higher for a few months sells off on outsized volume (double or triple their average, or more), with the best-performing stocks in the group breaking their 50-day moving averages, that group has almost surely topped.

Currently, that means the beloved commodity stocks have topped out; they took it on the chin last week and have been slaughtered this week.  Yes, even though commodity prices remain elevated, and even though all those stocks looked picture perfect just a few days ago.  That’s one of the things I’ve seen time and again–in the market, the landscape CAN change in just a day or two.  And when I see huge volume and breaks of important support levels, I can confidently conclude the intermediate-term trend has turned down.

But people have a difficult time changing their opinions that fast.  In fact, that’s exactly why the market trends; it takes time for people to eventually believe that a top or bottom is in place, and thus the market moves in that direction as more and more investors concluded that the tide has turned.

Don’t fall prey to that trap.  I believe that, unless you have huge long-term profits in these commodity stocks, you should be selling, into strength if possible, but selling either way.   Sure, longer-term (many months down the road), these stocks could ramp back up; nobody’s saying the overall bull market in commodities is done.  And there could be some that blast ahead on their earnings reports in the weeks to come.  But in general, I think these groups are ready to consolidate and correct after making heady gains the past few months.

Baidu: The Google of China

What about the bull side?  There’s obviously not much to get excited about, but the Nasdaq 100 (read: big technology stocks) is holding up relatively better than the other indexes.  And of the group, I like the action in Baidu.com (BIDU), the so-called Google of China.

You probably know the story–Baidu dominates the Chinese online search market, with about 60% market share, vs. 20% for second-place Google.  And that’s led to fast growth (revenues up 118%, 125% and 130% the past three quarters), though profit margins are deteriorating.  Still, the overall fundamental story is bullish, as more and more Chinese go online, and more and more firms seek to sell to them.

The stock itself suffered a whopper of a correction from January through March, plunging 53%.  I wrote the stock off at that point (stocks with that much damage often take a looooong time to recover), but BIDU rallied to within 10% of its peak in the spring.  And, encouragingly, it’s been shaping a new launching pad the last 10 weeks; during that time, the stock has faded a reasonable 20%, and it’s found some support in the 300 area of late.

Would I buy some here?  You could, if you already have a ton of cash on the sideline.  But I’m just going to keep an eye on it; the longer the stock can resist the market’s downtrend, the bigger the possibility that it will break to new peaks … especially if earnings come out better than expected.  (There’s no date yet for the report, but it’s likely out in mid-August.)  I’m putting BIDU back on my own watch list.

Until next time,

Mike Cintolo

Editor’s Note:  Michael Cintolo is Vice President of Investments, as well as the editor of Cabot Market Letter, whose growth stock investing roots date back to 1970.  In that publication, Mike uses his time-tested methods to find the leaders of a market uptrend, cash out when the time is right and hold on to his gains when the bears are in charge.  Since the start of 2007, the Market Letter’s Model Portfolio, which contains a maximum of 12 stocks, has trounced the market, thanks to winners like First Solar, Research in Motion, Visa, Continental Resources and GameStop … and thanks to timely market timing sell signals, allowing him to raise cash at the beginning of a downturn.  If you’d like to benefit from this advice, I urge you to give Cabot Market Letter a try.

http://www.cabot.net/info/cml/cmlim01.aspx?source=wc01

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