The Importance of Sell Disciplines
Parental Devotion
A Chinese Stock for Your Watch List
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Coming back from vacation is always hard. But for someone who, like me, works with stocks, coming back from vacation to a market that’s cranky and indecisive is doubly difficult.
There were plenty of scenic wonders on the North Rim of the Grand Canyon and in Zion National Park where my party of five spent last week. The Bright Angel overlook, Point Imperial and Crazy Jug provided the points of view and the constantly changing sunlight kept highlighting new features to appreciate. And a perpetually hungry mule named Fred and I forged a close bond on a trip halfway down a side canyon and back.
I got to see more of the Milky Way than I’d seen in years, plus condors, a water ouzel buffalo, beefalo, bats, ravens, lizards and minnows in spring-fed pools. I rubbed shoulders with people from all over the world, got up early to see the sunrise and stayed up late to see the stars. I climbed to the top of the exhausting (and exhilarating) Angel’s Landing in Zion and got knee-deep in the Virgin River.
A good vacation.
But, as I said, the sting is in the tail when you came back to a market with the late-summer croup.
The markets are suffering from the same malady that has been undercutting every attempted breakout rally since last January. Despite improved profits during the latest quarterly earnings season, investors can’t forget the potent combination of massive government debt, mountains of bad mortgages and mortgage-based securities and the reluctance of businesses to hire (or re-hire) more workers.
So, as always, the market is looking ahead by six months to a year and sees the risk of a new recession as just too darned high. So people are selling stocks and stock mutual funds and heading for the perceived safety of Treasuries or money market funds or even just tucking the cash into their checking accounts.
I don’t know what will happen, but I do know that every time the market declines, there will be a bunch of schnooks who will watch the price of their holdings decline and will do absolutely nothing about it.
Some will be deceived by hope (that things will improve). Others will fall prey to despair (that they will never get better). And many will just watch and wish that it weren’t happening, but will be unable to push the sell button and realize the loss.
Eventually, when the last of these hopeful, despairing or indecisive investors finally give up and exit the market with a vow never to come back, the market will find its support and begin to work on a new rally.
If you are a member of any of those three classes, I have just three words for you: Don’t do that!
Here is a sell discipline that is so simple that it can save you from yourself.
Go to your online brokerage account and write down the buy prices for each of your holdings.
Then multiply each of those prices by 0.85.
That will give you the exact 15% loss from your buy price that is your sell signal when the market is in a downtrend, as it is now.
For instance, the Cabot China & Emerging Markets Report bought China Valves Technology (CVVT) back in March at 13.97. The 15% loss limit on the stock was 11.9, which was tripped when the stock closed below that level in late April. (It’s important that you use closing prices, since growth stocks are volatile and can trip an intraday price level, then recover significantly.)
Our sell of CVVT above 11 got us out of the stock before it plummeted below 8 in June.
The stock bounced at that point, eventually working its way back to just below 12 before it rolled over again. But our sell discipline got us out with a minor loss and made it possible to preserve our capital to put into a stronger stock in a more supportive market.
An even better example is SinoHub (SIHI), a Chinese supply chain management and order fulfillment company that I put on the Watch List in late October 2009. The stock was too low-priced (at just 5) and thinly traded (43,000 shares a day) to make it into the portfolio, but it looked like a possible breakout candidate.
Unfortunately, SIHI began to languish soon afterward, and is now trading below 2. Fortunately, even if we had bought it, our sell discipline would have notified us to dump it long before it reached this pathetic state.
All you have to do it put a sticky note on your computer with the loss limits for each of your growth holdings, then follow the rules.
Remember, we always talk about buying opportunities. That’s because it’s fun to buy.
But we also talk about sell disciplines. That’s because selling is a drag and almost nobody wants to do it. It feels like admitting defeat.
Do it anyway. If you can’t do it, you may be better off with those Treasuries we keep hearing about.
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I have just one uplifting story from my previously mentioned vacation, and it has to do with the mule ride down the Grand Canyon.
The youngest member of our group of 15 riders was a girl of about nine years. Everyone in the group wanted to look out for this girl, but she was plenty game all on her own.
Well, almost all on her own, because her father, a slight man with a French accent wearing sandals and wool socks, shadowed our every move, shooting video all the while.
One thing you need to know about mules is that they are very big animals. They require a lot of input and their, uh, outputs are similarly copious. Every rider had the pleasure of sitting atop a beast that would occasionally stop short and make massive contributions to the canyon ecosystem, right there on the dusty trail. Let’s just say that all three states of matter—solids, liquids and gases—were in evidence.
But through our entire half-day trip, both down the steep, dusty trail and back up, the girl’s father never flagged. He doggedly trailed the mules on foot, making the video of his daughter’s trip while avoiding the mule’s byproducts.
While everyone in the group admired his devotion, nobody envied him the experience.
It was a testimonial to parental devotion. I hope the little girl appreciates his sacrifice.
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Back in March 2009, if someone had suggested that the Chinese jewelry company Fuqi International (FUQI) was about to embark on a six month run that would blast the stock to a 10x gain, they wouldn’t have found many takers. Seventeen months after its IPO, with three failed attempts to break through resistance at 12, FUQI was a flat-volume casualty trading just above 3.
But by the middle of September 2009, FUQI was just nudging 33 on huge volume. Ten baggers are rare enough, but to get one from a Chinese jewelry company was shocking.
Today’s stock is LJ International (JADE), a smaller company (sales of just $125 million annually, compared with Fuqi’s $467 million). This Hong Kong-based manufacturer of jewelry from gold, platinum and precious stones has been booking some excellent earnings numbers.
LJ’s four most-recent quarters have produced earnings growth of 150%, 50%, 600% and 800%, with after-tax profit margins of 7%, a multi-year high.
Earnings like that will get investors’ attention, and the trailing price-to-earnings ratio of 10 (and forward P/E of 8) doesn’t hurt either.
JADE is just organizing a nice breakout above its long-time resistance at 3, while FUQI is completing a monumental flop to 6 having been tainted by some bookkeeping questions.
I like it that JADE is resisting the market’s volatility and inching above long-term resistance.
I don’t like that it’s a very low-priced stock (which will keep many institutional investors from signing on) and that trading volume is low (just 124,000 shares a day, on average).
But the example of Fuqi International gives some credibility to LJ International. The Chinese appetite for gold jewelry continues unabated, and LJ International’s diversified distribution includes fine jewelers, department stores and TV shopping channels.
It will certainly be interesting to keep on your Watch List.
If you’d like more information about the stocks on the Watch List for Cabot China & Emerging Markets Report, you can grab a trial subscription here. The Report is the top-performing investment newsletter over the past five years according to Hulbert Financial Digest. And even more important, I have the Report’s portfolio 45% in cash right now in response to recent market weakness. Sound good? It’s easy to sign up.
Sincerely,
Paul Goodwin
For Cabot Wealth Advisory
