What to Do with the New Buy Signal

The Market Trend Turns Back Up

Off the Bottom vs. New Highs

Two Stocks on the Leader List
 

When I joined Cabot back in June 1999 (that was a quick 15 years!), the market was in sixth gear and we were helping subscribers make a ton of money in the Internet bubble. In fact, I was actually brought in to help write a new publication-Internet Stock of the Week. It did fantastically through about September 2000 before the weight of the bear market did its thing.

Anyway, looking back on it a couple of years later, we realized that because of the bubble, our market timing system had decayed. Because our system wasn’t working was a big reason we got nailed along with everyone else during the bear market.

So I (and Carlton Lutts, Cabot’s founder and one of the top students of the market you’d ever meet) did what any red-blooded, prideful American investor would have done in that experience-we did a deep dive into some systems and came up with the Cabot Tides. (Actually, it started as the Tech Tides, as that was such a dominant sector back then, but we soon broadened it to five indexes.) And it’s been one of our key indicators ever since, consistently alerting us to changes in the intermediate-term trend of the market.

(As a side note, one of my proudest “moments” here at Cabot was in 2008, when the Cabot Tides-along with our other indicators-told us to take profits early in the big 2008-2009 bear market. We averaged a cash position well above 50% in 2008, and were 90% in cash when the Lehman bankruptcy caused the levees to break.)

Of course, no indicator is perfect; the Tides are a trend-following measure, and thus, are subject to the occasional whipsaw and reversal. But in the long run, trend-following indicators have one undeniable, powerful advantage-they guarantee you’ll be heavily invested during every major uptrend, and guarantee you’ll be out of every major downtrend. And that alone will put you ahead of 80% of investors. Trust me on that.

Thus, while I’m always looking to improve, the Tides remain a staple of the market timing system, for our Cabot Market Letter and all of our growth-oriented advisories.

Why am I writing this brief history? Because, after a couple of months on a sell signal that saw many growth stocks decimated, the Cabot Tides turned bullish once again!

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Buy signals are great. I still get excited when we get a new buy signal, especially when it comes after two or three months of poor action. But far more important is what you do with that signal-particularly what stocks you purchase. And that’s where I get the most questions.

Obviously, any growth investor worth his or her salt is striving for great companies with big sales and earnings growth. But when it comes to charts, there’s a difference of opinion of what to look for, even among professionals.

Many prefer to buy liquid leaders that fell (but didn’t unravel) during the correction, and have found support and begun to rally. In the February market dip, we’re talking about stocks that fell maybe 25% or 30% or so, bottomed out during the past five weeks and are now pushing ahead … but are still well below their prior highs.

Other growth investors prefer to look for the most resilient growth stocks, even if they’re not as liquid or well known. In fact, they prefer if they’re not well known, as these new leaders are the ones that often put on the best shows.

What do I prefer? I always lean toward stocks that are close to new high territory. After all, if a stock didn’t fall much when its growth stock peers were being crushed, that’s telling you big investors were buying the dips and/or hesitant to sell any stock they already had.

Conversely, the stocks that fell 25% or 30% might be totally fine … but they might not be. Said another way, the odds are poorer for stocks that (a) got dragged down with everything else during the correction, and (b) despite a recent rally, still have lots of overhead (potential selling from investors that bought at higher prices). That last issue is something stocks at new highs don’t have to worry about-everyone has a profit and is happy.

I don’t think you have to be ideological about it, though there are definitely times when buying stuff coming up off its lows works terrifically-after all, how many times have we seen some big liquid leaders resume their advance after a market decline? That said, most of the best performers during a rally phase are the first ones out of the gate, so you always want to be watching resilient stocks during a correction.

All of that leads us to today’s market environment-because of the Cabot Tides, there’s enough evidence to tell me to put my optimist’s hat back on. But it’s not as if there are two dozen big, liquid institutional leaders bursting to new highs on huge volume; most of the liquid leaders of the past year are still 10% or so below their old highs and have already popped higher in recent days.

As for the growth-oriented stocks at new highs, there aren’t a lot of them to begin with, and those hitting new highs tend to be more thinly traded. So what to do?

I think it’s fine to split the difference, possibly buying one of the potential new leaders that’s already hitting new highs, and one off-the-bottom former leader that could continue its comeback.

On the new leader list, one name I like is Arris Group (ARRS), which was my Top Pick in Cabot Top Ten Trader on May 19, before the stock leapt to new highs. The ruling reason for the company’s strength is that after years of little investment, cable TV operators (including telco firms) are spending big money to expand bandwidth so they can offer various video services, faster Internet speeds and the like. Basically, the fear of over-the-top services like Netflix (which can lead to “cord cutting” and falling subscriber totals) is forcing this upgrade cycle.

Thanks partly to its fish-swallows-whale purchase of Motorola Home last year, Arris is going to be the main beneficiary of this spending. Business is already growing like mad, and the first quarter saw orders mushroom, a great sign for the future. Of course, at some point the party will end, but management believes it’s still in the early innings of this cycle. ARRS was one of the first stocks to power to new highs last week, and I think it’s buyable around here, with a stop in the 28-29 area.

On the off-the-bottom side, I am intrigued by TripAdvisor (TRIP), which is a much easier business to understand than Arris. It’s the leading travel information site on the planet, with millions of hotel, vacation rental, restaurant and attraction listings that are read by more than 260 million unique visitors each month. Those visitors have generated north of 150 million reviews (including more than 100 new reviews every minute!).

TripAdvisor makes 85% of its money via advertising, with the rest coming from premium subscriptions and the like. And business is very good-revenues consistently grow in the 20% to 25% range as it monetizes its user base, while cash flow has been excellent. And analysts see earnings up between 25% and 30% every year through 2019! I’m not exactly looking that far ahead, but the point is that TripAdvisor is still in the middle innings of its growth.

The stock pulled back a sharp 32% during the correction, but it banged out a bottom in the high 70s for a few weeks and has already surged back toward the century mark. There’s resistance up to 110, but buying a small position on dips of a couple of points should work out well if this market rally persists.

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Sincerely,

Michael Cintolo
Chief Analyst of Cabot Market Letter
And Cabot Top Ten Trader

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