Defense may win games, as the sports cliché goes, but it’s offense that fires the imagination. I’m willing to bet that for every kid who dreams of making a big defensive play, there are a dozen who want to hit the walk-off home run, throw (or catch) the game-winning TD pass or sink the three-pointer at the buzzer.
Similarly, I doubt that there are many stock investors who dream of bragging about how much they have limited their losses by being in cash as markets have declined.
Well, they should.
The one thing that many investors forget is that the market isn’t really neutral. The market actually wants to take your money away! If you’re an individual investor, you’re up against an unholy alliance of hedge fund managers, mutual fund managers and institutional investors who spend every hour of every working day looking for the little advantage that will allow them to beat their assigned benchmark index.
And there’s nothing that pleases them more than for individual investors to bid up stocks that are already too high (allowing the pros to sell near the top) and to hold on to stocks way too long into their declines (setting up even better buys at the bottom).
Stock Market Defense
As individual investors, especially the growth investors that I write for, you have to have a strategy that will keep you from being a major contributor to someone else’s stock gains. The best one I know is yet another cliché: Cut your losses short.
Chairman Mao may have said it best: “When the enemy advances, we retreat. When he retreats, we advance.” It’s the quickest summary of effective guerilla war ever penned, and Mao used it to good advantage in his various campaigns against foes both foreign and domestic.
But if you just substitute growth investing for guerilla war and a bear market for the enemy, it works just as well. Mao was warning that a small force shouldn’t try to dig in and fight it out against a larger one. But his logic works equally well for an individual investor under assault by a bear market.
It sounds too obvious to be of much use, but that’s the genius of it.
When the bears are in charge and the market is going down … get out! The worst bear market in the world can’t take away money that you have in cash.
So if it’s so obvious, why don’t more people do it? The answer is that we’re trapped by our own psychology. It’s a well-documented truth that people are unwilling to sell a position in which they have a loss.
Psychologically the selling makes it official and forces a person to face failure. I think it was Charlie Brown who said that no problem is too big to be run away from. Good thing he’s not an investor. But even if he were, he’d have plenty of company. I’ve heard so many people say things like: “That stock has fallen way too low to sell” that it makes my head spin.
Someone once called second marriages “the triumph of hope over experience.” Well, it’s OK to allow hope to be in charge when you buy a stock. But when one of your holdings tumbles, you’d better be able to put hope in your pocket and kick the offender out of your portfolio before the damage is too great. The Cabot guidelines set loss limits at 20% below your buy price when markets are healthy, and 15% when the bears are in charge.
Of course selling stocks is hard! If it were easy, everyone would do it. There’s a reason the rules for selling are called your sell disciplines. Discipline is hard. However … no discipline, no profits.
If you get only one tattoo this year, this should be it. Cut Your Losses Short.
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If This Goes On
Does anybody else besides me remember the people who were fearlessly predicting that oil would be topping $200 a barrel soon? If so, congratulations! You’ve just learned a valuable lesson about the utter futility of predicting the future.
Predictions about the price of crude were a particularly short-sighted version of the prognosticating fallacy called “If This Goes On.” The If This Goes On fallacy goes wrong by just extending the present trend into the future without taking any moderating influences or complex variables into account.
This is the fallacy that takes rising hemlines on women’s dresses and forecasts that hems will be up around people’s navels in another year or two. It also shows up in simple projections of Americans’ weight that take past gains and extend them into the future. If you saw the lumpy couch potatoes in the Pixar animated feature Wall-E, you know what I mean.
Predictions about the price of crude oil were almost self-liquidating, but no one talked about that possibility when the black stuff was topping $140 a barrel. The price of oil is a function of demand, but the $200-a-barrel people didn’t think that really expensive oil (and gasoline and diesel fuel and home-heating oil) would put such a quick lid on demand. They also didn’t think about how the inflationary effects of high energy prices (and the recessionary pressure that would result from the high interest rates necessary to keep inflation at bay) might dampen economic growth, thus leading to … you guessed it … lower demand.
Whenever I listen to economic advisors, scholars and predictors, I always remind myself of my favorite quotation from Peter Drucker, the legendary management consultant. He said: “Anyone who tells you that he understands the American economy ought to be sent to teach modern dance.”
Forecasting complex events is impossible. Investing on the basis of anyone’s forecast is dicey. You’re an individual investor and the one advantage you have over institutional behemoths is your ability to jump in or out of a position quickly. If you give up your agility, your edge is gone, and you’re at the mercy of the fearless predictors. I wouldn’t do that if I were you.
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Banking on India
My stock idea for today is a big Indian bank, ICICI Bank (IBN). This private-sector commercial bank has grown from an arm of the World Bank into one of India’s leading banks. It introduced ATMs into India and was the first Indian stock to list on the New York Stock Exchange. With well over 700 branch offices, the bank is reaching out aggressively to the growing Indian middle class, and when the Indian economy gets back on the growth track, it will represent a real opportunity.
Right now, India is fighting the good fight against inflation, which means that interest rates are high. High interest rates put a damper on mortgages (in which ICICI is a domestic leader) and auto sales (the financing of which is also a strong point in the bank’s business).
The dampening effects of rate hikes have pushed IBN down from 74 to 32, which is a heck of a haircut in anyone’s book. But the stock is now tightening up at 32, with narrowing swings of both highs and lows. This kind of chart pattern often leads to a useful base, and eventually to a breakout into another rally.
IBN is a perfect stock for your watch list as you ride out the current bear market. Presumably you’re heavily in cash in your portfolio, which allows you to laugh at the winter of the stock market’s discontent.
When IBN starts to rise again, you should look for the rising price and soaring sales volume that indicates increasing support and jump in.
Editor’s Note: Cabot China & Emerging Markets Report is now 70% in cash. It’s this cash position that has allowed the Report to remain the top-rated investment newsletter in the ratings of the Hulbert Financial Digest. When the bear attacks, cash is king. But the real fun will start when the emerging markets get back into gear and begin their next bull run. If you’d like expert, proven advice about how to get the most out of investing in emerging markets, a click on the link below will get you started on a risk-free trial subscription.
For Cabot Wealth Advisory