The Certainty of Uncertainty
Put Your Best Foot Forward
Three Stocks for the Strong Market
I like to think I have a few good traits, but one of them is certainly NOT being handy. Giving me a hammer and nails, or a paintbrush, is as likely to result in a job well done as … well, let’s just say as a job that needs to be re-done, or worse. Don’t get me wrong–I still mow the lawn, do the weeding and even use the Weed Wacker occasionally. But when it comes to anything that needs a tool belt, I’m lost.
More than that, I an understanding of how many things are actually put together. What can I say? It’s just not my strong suit.
So you can imagine my uneasiness when my wife and I bought a house last year. The house is nice, but old–it was originally built in the 1930s as more of a cottage, but has been expanded many times over the years. And, let’s just say the prior couple of owners did a lot of the handiwork themselves … not all of it very good. Even so, we got a great deal with a great interest rate, and were able to move into a nice town. No problem!
Of course, soon after we moved in, we found some problems, 90% of them minor. But one day, after a rainstorm, we noticed the ceiling in our small sunroom began to crack a little bit. And then came some slight brown spots. And then some more. Groan! Obviously there was some water seeping in somewhere.
At this point, panic set in. What is really going wrong? Is it the skylights? Is the roof messed up? How long has the water been seeping in there? Is there any rot? Mold? And, most important, what will it cost to repair? It was stressful!
During the next few days, I was like Sherlock Holmes examining every inch and corner of that ceiling in detail. Soon we had a trusty contractor in, he diagnosed the problem (simply put, our flashing stinks), and we actually decided to have two old skylights replaced in the process. And we got a quote, too.
Well let me tell you–once I had that quote in my hand with the likely diagnosis, the stress disappeared. I no longer had to worry or consider endless possibilities. Even though the repair would set us back some money, I didn’t have to guess how much it would cost, how long the repairs would take and, most important, I wouldn’t have to worry about whether the next rainstorm would cause more damage.
In other words, the situation was defined–the uncertainty was gone. And with that, my wife and I were able to make a logical decision of what step to take next, and move on to something else.
In the world of investing, uncertainty can make investors do strange things–panic out of stocks at the wrong time, invest too much or too little in a promising stock, or make some other major error. Sometimes, uncertainty can make investors swear off the market altogether!
But the fact is, you can never be certain of anything in the stock market. Nothing! So it shouldn’t be a surprise that of all the successful investors I know of, deal with uncertainty exceptionally well … while poor investors do not, and pay the consequences.
So how should you deal with uncertain markets? Really, it’s a two-step approach. First, you want to decrease that uncertainty to some extent–you do have that ability. Second, frankly, you want to learn how to deal with the remaining uncertainty by focusing on something else. I’ll explain what I mean below.
On the first front, the easiest way to decrease uncertainty is to define your risk–i.e., use a stop (mental or an order in the market) to cut ALL losses short, as well to have a worst-case scenario with your winners. When you combine this with prudent position sizing (read: not putting all your money in one or two stocks), you’ll be able to go to sleep at night knowing your risk.
One great trader once said that you can’t predict what the market will do, but you can be prepared for all the potential happenings. That’s basically what I’m saying here–having a plan for all contingencies decreases your uncertainty.
On the second point mentioned above (dealing with whatever uncertainty remains by focusing on something else), the idea is to not obsess over the uncertainty that will always be there. How do you do that? By focusing on things that matter–namely, the price and volume action of the stock itself (which tells you what big institutional investors are thinking), the company’s fundamental story, and your own trading plan. That way, you’re not finding things to get worried about–you’re “planning your trade and trading your plan,” as they say.
Now, if you’re the overconfident type, this article likely doesn’t help you much; maybe you need some help looking at what can go wrong, instead of just focusing on the optimistic side of the fence. But in my experience, many investors become paralyzed by all the things that could go wrong … even though most of these fears are never realized. Following the simple steps outlined above can solve that problem, allowing you to focus more on what we all like to do–finding and buying winning stocks.
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On that front, the market is showing all of us a tremendous amount of strength. Amazingly, on Wednesday, a whopping 602 stocks on the NYSE reached new 52-week highs–that’s the highest reading in years, and it has two implications.
First, in the short-term (say, the next two or three weeks), it’s likely that the market and many stocks could hit a rough patch. The huge number of new highs effectively tells you that enthusiasm has reached a crescendo … and when that happens, the late buyers are usually punished. So I think a modest choppy period with the major indexes falling 2% to 4%, as well as some damage to leading stocks, is likely.
Long-term, however, such a huge number of new highs tells you the market’s breadth is outstanding. And bull markets do not end until the breadth of the market fades for many weeks or longer–when the generals advance while the troops don’t follow. There’s no sign of that now, and the power of this recent advance tells me there’s lots of pent-up buying pressures still out there.
So what’s the game plan? First, I think now’s a good time to get rid of any stocks you own that haven’t been pulling their weight; if they haven’t been able to bounce much in recent weeks, or are still well below their peaks from last fall or early January, they’re likely not leaders. And that means they could get hit further should the market begin to consolidate and correct.
Second, if you so choose, you could lighten up on some of your winners … although that’s not my preferred route. True, some stocks that have just bolted 15%, 20% or more could easily pull back and cause some pain and discomfort. But seeing as how the market just confirmed its new rally at the start of this month, I think the stocks that have shown tremendous power are those you want to hold on to … or even buy more of.
Which brings me to my third piece of advice: You should be looking to buy on weakness in the days ahead. While it’s true there are likely to be a few more powerful breakouts going forward, your best leading stocks have probably already hit new highs. So look to nibble on those names on weakness. Here are three suggestions:
Cliffs Natural Resources (CLF) is in a great position to capitalize on the soaring price of iron ore. A few analysts, in fact, have recently raised their earnings estimates to $7 to $8 per share this year, up from $1.19 last year! The stock is exceptionally powerful–it’s risen from 40 to 67 on huge volume during the past six-and-a-half weeks. I think any retreat toward 60 would be attractive.
Ford Motor (F) is a turnaround story with legs. Analysts estimate 2010 earnings could come in around $1 per share, though we think there’s a good chance those numbers are conservative, especially given the firm’s debt-rating upgrade this week, which could slash interest costs over time. The stock has rallied from 11.5 to 14.2 during the past three weeks, and this is likely to be the stock’s eighth straight weekly advance, a sign of persistent demand. A retreat into the mid-13s would be tempting.
F5 Networks (FFIV) looks like the leader of the strong networking group. The stock is working on its sixth straight up week, motoring from 47 to the mid-60s during that time. Sales and earnings growth has been gradually accelerating, and that trend is forecast to continue. The big picture here is that corporations are opening up their wallets to spend on IT again after an 18-month hiatus, and F5’s products are some of the best out there. A dip to 60 would be enticing.
Until next time,
For Cabot Wealth Advisory
Editor’s Note: Cliffs Natural Resources, Ford and F5 Networks are all Cabot Top Ten Report stocks, hand-selected by Editor Mike Cintolo with the aid of OptiMo, our proprietary momentum stock-picking system. To get more of Mike’s top picks, along with both the technical and fundamental reasons why he likes these stocks now, try Cabot Top Ten Report today!