Smart Investors Ride the Wave

Hard Times May Be Good News

Staying Afloat, and Then Some

Yahoo! With a Chinese Accent

I don’t mind telling you that these are scary and depressing times for investors.  One wave of bad news no sooner breaks over us than another one–even bigger–appears.

The American banking and auto industries are circling the drain, and the Dow, which was within spitting distance of 14,000 just a year ago is now, having cracked the 8,000 level, trying to decide whether to rest there for a while or just plunge further.  If you had bought a Dow index fund in July 1997, you might be exactly even now.

Billions of dollars in stock value have been lost and nations are expending trillions in debt to try to shore up credit markets and limit the depth of the recession that’s now officially confirmed in the U.S., Europe, Japan and lots of other countries. 

All in all, it’s enough to make you turn off your TV, limit your newspaper reading to the sports and funnies and abandon your computer for your game console.  At least in World of Warcraft, you know the rules.

Believe me, this deluge of bad news hits financial writers, too.  Cabot Market Letter’s Model Portfolio and Cabot China & Emerging Markets Report’s portfolio, between them, have zero stocks.  They’re both fully in cash, which means that the declines in stock markets in the U.S. and the emerging markets just makes their relative performance look better.  But the market is still depressing.

It’s rewarding to have warned people away from a dangerous bear market, but it’s no substitute for the thrill of the hunt, finding great growth stocks, telling people about them and then watching them rise.  We know that money saved is money that can be put back to work when markets turn up, and subscribers have told us that they appreciate the money we’ve saved them.  But we get impatient like everyone else.

One idea that we’re actually happy about is the notion that markets may (note the emphasis on may) be nearer to a new bull phase than the toxic headlines would lead you to believe. 

We have three big pieces of evidence for this contention.

1.) Extremes lead to reversals.  The concept of reversion to the mean applies to any situation in which values move toward the limits of a central tendency.  In this case, the price-to-earnings (P/E) ratio of the broad-market S&P 500 Index averaged 17 from 1955 through 2005.  The spike to over 45 during the height of the Tech Bubble signaled a huge divergence from that mean, and when the Bubble burst, the P/E headed right back to the average. 

Today, the P/E ratio of the S&P 500 Index (based on trailing earnings) is between 10 and 11.

2.) History tells us that markets lead economies out of recessions, and not the other way around.  Stock investors make money by looking at where markets are headed, not where they’ve been.  The collective wisdom of the entire population of equity investors has always been a better predictor of where the global economy is headed than any leading indicators or economists. 

3.) Markets always bottom out and start their recovery while headlines are at their gloomiest.  Again, that’s because the headlines are telling you what happened yesterday, while the markets are like camels that can sniff water 20 miles away. 

Predictions are not part of the Cabot growth investing discipline. I don’t even try to make them.  Strict avoidance of predictions is built into the market timing indicators that we use to advise our subscribers when to be in the market and when to get out.  It’s why we avoided this disaster!

So I can’t say that I think things are about to get better.  But I can say that it’s when things are at their worst that improvement begins. 

Taken together, these reasons point to the possibility that the markets may be putting in a bottom.  Then again, they may not.

The important thing is that Cabot’s growth disciplines will recognize the new uptrend soon after it arrives and will begin finding the leaders and telling our subscribers.  Then it’s just a matter of following the rules: Let winners run.  Cut losses short.  Stay on the right side of the market.

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Where to Find the Next Big Thing

Cabot’s proprietary screening software ferrets out the 10 strongest stocks each week, no matter what’s happening in the market. The Report routinely beats the market by finding strong leaders like these past picks:

In 2005, Hansen Natural gained a whopping 570%. In 2006, NutriSystem was up an amazing 480% in 11 months. Last year, stocks like JA Solar were up 200% in seven months, DryShips was up 510% in 10 months and Research in Motion was up 149% in seven months.

Even during this year’s bear market, Cabot Top Ten Report has found winners in stocks like Cleveland-Cliffs, which doubled in four months, Continental Resources, which rose 160% from its recommendation to its peak, and Walter Industries, which rocketed from 42 in January to 112 in early July.

During the last year and a half the average stock featured in Cabot Top Ten Report has produced 30% actualized gains, so click the link below to discover the strongest stocks in the market today.

Back in my university professor days, I used to speak to community and professional groups on communication topics.  Inevitably, these talks often got around to putting communication into action.  One image I used to explore the plight of a small business trying to decide on a communication strategy is “The Four Things You Can Do In the Water.”  It goes like this.

If you’re in the water, there are four things you can do.

The first is drown.  Let’s keep that in mind, because if you do nothing when you’re in the water, you really can sink, die and disappear.

The second thing you can do is float.  It has the advantage of not drowning, but unless you trust the tide to put you on the shore or you think someone is going to come along and rescue you, that’s about it. 

If drowning and floating don’t suit you, the third thing you can is swim!  All of a sudden you have a direction, momentum and some control over your destiny.  Good for you!

But there’s a fourth option, one that not many people think about.  You can surf.  Surfing is just finding a wave, letting it pick you up and falling down its face for as long as it will carry you.  If you can find a wave that’s heading in your direction and ride it successfully, you can outdistance even the strongest swimmer while expending just a fraction of the effort.

So, what does this have to do with investing?  (You knew there had to be a connection, right?)  Well, it wasn’t what I had in mind when I first wrote the image up, but here it is.

The person who drowns is the person who does nothing with money.  No budget, no plan, no savings, no investments.  Nothing.  This is the neighborhood of huge debts and bankruptcy, which is about as close to drowning as you can get in the financial world.

The person who floats is the person who saves.  The more you save, the bigger your financial cushion is, but you hear stories every day about people whose savings have been blown away by illness or some kind of accident.  Money in the cookie jar or under the mattress is better than nothing, but that’s the best you can say about it.  Completely safe investments–an insured savings account or a Treasury bond–will at least allow your money to grow fast enough to keep up with inflation. 

The person who swims is the one who invests.  Investing in anything from an index fund to a highly leveraged derivative always involves risk, and the relationship between risk and reward always follows the same formula.  Low risk investments bring low returns.  The more risk you are willing to take on, the higher the potential reward. 

The surfer is the investor who figures out which direction the market is going and gets in step with it.  This takes skill and nerve, and there is always the chance of wiping out.  But if you ask an investor who has ridden a bull market what it’s like, the answer will be ecstatic.  It’s not just the money–although that’s a huge part of it.  It’s the sense of being locked in to a bigger movement.  Skiers and snow boarders can get the same feeling.

Cabot’s growth advisory letters–Cabot Market Letter, Cabot Top Ten Report, Cabot China & Emerging Markets Report and Cabot Green Investor–use market timing to identify positive market conditions, essentially telling you when the investment surf is up.  Their advice is especially important when market conditions are negative.  Knowing when to get out of the water is how surfers–and investors–stay safe.

My investing idea today won’t be a surprise to anyone who follows Chinese stocks even slightly.  It’s a company called (SOHU), a Web portal that’s often called the Yahoo! of China.

For many Chinese, is their window to the world.  The portal offers an enormous range of information and activities, including search, news, sports, entertainment, gossip, games, affinity groups, alumni groups, financial information, real-estate services and lots more. 

The company was a big sponsor of the Beijing Olympics, streaming many events and offering background information on athletes, medal counts, results and color commentary.  Sohu got huge exposure from the deal, which lead to a huge spike in visits to the Web site and increased minutes spent there.

The company generates revenue from a standard mix of keyword search fees, games and paid advertising.  Results for the last four quarters have featured year-over-year earnings growth of 105%, 256%, 410% and 260%.  It’s not surprising that institutional ownership has hit a new all-time high of 134, which is substantial, but leaves lots of room for growth.

The stock has been in a downtrend since peaking at 92 in June, falling heavily as investors have grown progressively more defensive.  Now trading at about 37, the stock has fallen through what should have been its support level at 40.  It’s not in free fall, but it will need to find a new support level and build a base before it’s really buyable.

I think it will be a great addition to your Watch List, and should do well when the world comes out from under the clouds.

Paul Goodwin
For Cabot Wealth Advisory

Editor’s Note: Growth investors are those who can still see that the lower the markets slide, the bigger the opportunities will be when they start to soar again.  If that’s you, and if you’d like to get word when China and the emerging markets get back in gear, this would be a perfect time to learn the lay of the land and get ready to welcome the bulls back. Cabot China & Emerging Markets uses proven market timing to get subscribers in and out of the market at just the right times, which have saved them from much of this bear market. Click the link below to learn more about you can get started today.


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