Focus on the What, Not the Why
Don’t Operate from a Position of Fear
Great Story, Great Numbers, Great Chart
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For the long weekend, my wife, daughter and I headed up to a beautiful small lake in New Hampshire; two of my buddies have houses on the lake, and we were up there from Saturday morning until Monday evening. We partook of the usual array of July 4th activities--BBQ’ing, swimming, boating, relaxing and just generally hanging out with friends (including a pseudo-celebration of one friend’s recent engagement). As always, we had a great time, and it really kicked off the summer season for us.
Of course, while chewing the fat with some pals, the conversation often touches on the stock market; none of them are professionals in the field, but all are involved through retirement accounts, college plans and the like. So they keep track of what the Dow and their various funds are doing.
This year, one of my good friends came out and said something that stuck in my mind: “Wow, what a week for the market ... but for what!? Just some halfway decent news from Greece and the Dow spikes 600 points? That makes no sense,” as he shook his head with a laugh and headed off to the cooler.
Another friend simply noted the Dow had been on a tear and asked me, “What caused that?” My reply was a truthful “I don’t concern myself with the why as much as the what,” to which my friend gave me an odd look and quickly changed the subject.
My point here is that the vast majority of investors (even many professionals), think the WHY is just as, if not more, important than what the market actually did. If a stock or index rallies in huge volume on little news, most investors perceive it as fleeting. But if a stock or market rallies because of an obvious news item, investors jump for joy and are convinced that the upmove will persist.
But in real life, the news of the day is not that important. It’s true! As I said to my friend, the fact that a stock or market moves one way or the other on humongous volume is all you need to know. Actions (big investors plowing money into a stock) speak louder than words (news).
Now, don’t get me wrong; in some cases, such as earnings reports, our historical research and experience tell us huge gaps following these reports usually lead to a continued move. So some news items are important. But notice in this case, the key is how the stock reacts (the big gap) to the news--not the news itself (what percent earnings were up or down, etc.).
That leads me back to last week, when, out of nowhere and for little reason, the market and most individual stocks took off like a rocket without pausing for breath; every index spiked back above its key 50-day moving average and most stocks did the same.
Optimism over a potential Greece deal was the supposed reason for the ramp, but then again, S&P dumped on that deal over the weekend (and then Moody’s downgraded Portugal to junk status on Monday) and that didn’t do much damage to the market this week. So what was the reason for the advance? We’ll probably only find out many weeks from now, because the market is a discounting mechanism and is likely sniffing out better than expected growth in the months to come.
The moral of this story is that it’s better to view the market as its own entity that is separate from everything else; that’s not to say it really is separate, but if you try to figure out reasons why the market is up or down every day or week, you’ll find yourself frustrated and confused. As they say, you should believe what you see--i.e., focus on the market’s own action and ignore the noise.
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With our market timing indicators, which helped subscribers avoid the worst of the recent plunge, flipping back to the buy side last week, we began putting some money back to work in strong stocks with terrific growth stories.
But, of course, that can be easier said than done--with the market surging a few percent in the past few days, most investors are hesitant to put much cash to work in stocks that have just spiked 10% or 15% in a week’s time. Then again, they don’t want to miss out on the rally if it continues.
So what do they do? They put some money to work in a couple of stocks ... but as soon any brief pullback or shakeout comes (maybe on some “bad” news), they sell, cursing themselves for buying after such a big run-up. Then, after they sell out, the market begins pushing higher again and these investors are left buying back in again at higher prices. Like a dog chasing its tail, the cycle repeats, and the investor loses money despite an up market.
I guarantee that, if this bull move continues, many people will suffer through this exact scenario. The lesson is that, when investing in individual stocks, you must (must!) have some conviction in your stock. If you don’t, you will get shaken out on normal weakness and during inevitable shakeouts.
A corollary of this is that you shouldn’t invest in the market from a position of fear--akin to the sports team that plays “not to lose” and gives up a big lead, if your overriding goal is to not lose money, you’ll probably get kicked out of any stocks you own at the least opportune time. Of course, you still need to have prudent loss limits and to be aware of your overall risk. But surviving the seemingly random one- or two-day shakeouts is key.
Consequently, as you look to put money to work, I recommend you take two simple steps before you buy a stock. First, set a loss limit ahead of time and be sure you would be comfortable losing that much (should it come to that). That way you won’t freak out should the stock have a couple of bad days.
Second, be sure you have some conviction in the company’s fundamental story. That way, if a bad news item comes out that’s not overly significant (rumors of competition, for instance), you won’t let go of all your shares. If you don’t, you’ll be kicked out as soon as a bad news item is released.
I realize that neither of these items are revolutionary, but it’s important not to fall into the pattern of repeatedly getting shaken out should last week’s lift-off continue.
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For my stock idea in this issue ... well, it was hard to choose just one. So many stocks have formed good-looking launching pads (some as long as six months) with many breaking out during the past few days. However, now is not the time to get sloppy--many names have been levitating on light volume, which doesn’t actually inspire confidence heading into earnings season.
Instead, you should look for the stocks that have great stories, great growth and great volume clues, which tell you that big investors are building positions. One name to watch is Fortinet (FTNT), which is the leader in the new, fast-growing field of Unified Threat Management. Here’s what I wrote in Cabot Top Ten Trader two weeks ago:
“Fortinet calls itself the worldwide leader in Unified Threat Management, a new sector that’s growing like mad as companies race to upgrade network security. The company’s flagship product, dubbed FortiGate, can provide firewall, application control, intrusion prevention, Web content filtering, antivirus and anti-spam services--all in one device. Simplicity and cost savings are the big advantages, but it also appears that Fortinet’s products are better at handling the new network reality, where everyone is connected using a variety of devices. While earnings estimates are a bit low, the company regularly trounces estimates, and we love the trend of accelerating sales and earnings growth. With many clients signed up on a subscription basis (read: lots of recurring revenue), Fortinet’s results should continue to impress.”
The stock has had a big run since originally breaking out of its first base in August of last year. But shares refused to budge during the correction, and impressively, FTNT has bolted ahead 12 days in a row to new highs on good volume. It’s clear that big investors that own shares never let them go, and now they and others are increasing their stakes. The stock is a bit extended here, but that’s a good thing if the market is really in the early stages of a new advance.
Bottom line, I think you could buy a little around here, or, hopefully, pick up shares on a normal dip of a couple of points.
All the best,
Mike Cintolo
Editor of Cabot Market Letter
Editor’s Note: Mike Cintolo is VP of Investments for Cabot, as well as editor of Cabot Market Letter, a Model Portfolio-based newsletter of the best leading growth stocks in the market. It’s been four and a half years since Mike took over the Market Letter, and during that period he’s beaten the S&P 500 by 13.3% annually thanks to top-notch stock picking and market timing. If you want to own the top leaders in every market cycle, be sure to give Cabot Market Letter a try by clicking HERE.
