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The Perils of a Bull Market

Today I’ll give you a short list of the biggest challenges of bull markets, plus a little advice about how to deal with them.

The Perils of a Bull Market

What’s in a Name?

A Chinese Stock with Big Ambitions Hires Some Talent

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When stock markets are declining and investors wish for a rally as eagerly as teenagers wish for summer vacation, it’s hard to stay upbeat. It requires patience (which is boring) and discipline (which is difficult). Every stock investor is familiar with the woes and worries of a bear market. When nobody’s making money except the short sellers, most of us just curl up into a ball and get depressed.

That’s the case even if you follow the Cabot growth investing disciplines, which tell you to cut your losses short, move to cash and work on your watch list. Even if you’re not losing much money, sitting on the sidelines just isn’t much fun.

But now that the markets are showing real signs of life, giving us buy signals in the Cabot Market Letter and Cabot China & Emerging Markets Report, a different set of worries shows up. And they’re the kinds of problems that aren’t obvious when you’re wishing for the bulls to take charge.

So here is a short list of the biggest challenges of bull markets, plus a little advice about how to deal with them. (Remember: I’m a growth investor, so this may be a little aggressive for the committed long-term devotee of buy-and-hold value principles.)

Picking the Stock -- When the market is rallying, there are always more attractive targets than your hypothetical portfolio has positions. A quick look at the best charts from January will definitely have your head reeling. So how do you decide which stocks to jump on in such a target-rich environment?

First, you need to get a picture of the perfect stock in your head. You want it to have a chart that shows strong price advances, indicating that it’s being bid up by enthusiastic investors. You also want to see rising trading volume, which is often a good indication that institutional investors are in the hunt.

Second, you want to find companies that are achieving bottom-line success, which is indicated in rising revenues and earnings.

Third, you want to find a stock whose story makes sense to you. It should have a product or service that has the potential to reach a much larger population of buyers. This may be in the form of a unique technical innovation or a way of cutting costs or an economic trend that will bring buyers around in droves. Be careful with this step, as the kinds of stories that make great sense at cocktail parties often don’t pan out in the real world. If your great story doesn’t have the support of good bottom line trends and a rising chart, you should be skeptical.

Pulling the Trigger
-- Once you’ve selected a stock that’s hitting on all three of these cylinders, you need to decide when to actually buy it. (Remember that the moment you buy a stock is your moment of maximum exposure, so you need to protect yourself from sudden pullbacks. Stocks that move up quickly can move the other way with equal speed.)

The two classic ways to lower your risk at the moment of purchase are buying on dips and averaging up. (you can find all of this Cabot growth investment advice on the Cabot website. And, not to sound too salesy, but a subscription to one of the Cabot growth newsletters like Cabot Market Letter or Cabot China & Emerging Markets Report will spare you much of the anxiety that stock selection, buying, selling and portfolio management can cause. To find out more about Cabot Market Letter, click here. To learn more about Cabot China & Emerging Markets Report, click here.)

Stocks that are vaulting up the charts will often either correct sharply or trade sideways for a while as they wait for new buyers to push them higher. A dip to the stock’s 25-day moving average will often lead to a new advance, and is a fairly reliable buy point. So is a stock’s first dip to its 50-day. Watching for these moves and “buying on the dips” can get you into a stock at a useful discount.

The other way to keep your immediate risk down is to buy a smaller position than you typically would. We recommend about half of the usual dollar amount you allocate to each stock.

Selling -- Although it sometimes seems like every stock goes up in a bull market, your rational mind will tell you that’s not true. Sometimes it’s a bad earnings report that holes your stock below the water line, other times it’s profit-taking and sometimes it’s just a bad piece of news that affects the whole market.

Whatever the reason, if a growth stock in your portfolio has dropped 20% below your buy price at the close of any trading day, you should consider selling it. That’s the essence of the Cabot sell disciplines for growth stocks. (We tighten up that loss limit to 15% when the bears are in charge, but I don’t want to think about that now.)

Now listen very closely. This is important. Selling is very, very, very hard to do well. Sometimes you don’t want to sell because the stock that has given you a 20% loss is rebounding. Sometimes your loss is just too big, and you tell yourself you’ll wait for a rebound. And sometimes you just give up and refuse to think about it.

Here’s the big lesson: If you can’t bring yourself to cut losses short, you probably can’t make money as a growth investor. Growth investors typically make money by finding one or two really great stocks per year and riding them to big gains. This works only if you can prevent the one or two stocks you buy that really tank every year from eating up your profits.

I hope I haven’t made growth investing sound too tension ridden. For an investor with the right temperament, it’s actually fun and stimulating, and the returns can be quite rewarding. It’s almost like going to Las Vegas, but you can improve your odds by following a few simple rules. The casinos work very hard to be sure you can never get an even break, but the market is a little more forgiving ... if you follow the rules.

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I used to work for a company that (among other things) helped to find names for new companies. So I’m always sensitive to cycles of naming strategies, as it seems that companies looking for a name that communicates their dynamism or their tech savvy go through phases.

So it occurred to me a while back that I hadn’t seen any new businesses using “works” in their names any more. That seemed odd, because it used to be one of the most popular suffixes for any business trying to give itself a slightly industrial, artisanal feel.

Heck, I even used to work at a small business that was part of the tide (Cineworks, a small film and video production company).

There is still a Boston Beer Works, and a PrintWorks, and a Bavarian Auto Works, and a Body Works gym and etc., etc. But it’s not a name out there on the cutting edge any more.

Then I realized that the whole “works” thing had been dead for years, and that naming had been through at least two generations before I noticed.

Some time after the “works” era, there was the “X” and “Z” era with its implications of Xperimental and Xtreme and a letter that was made hip by Zorro. The X reached back to both X-rays and the X- series of aircraft and the Z is the last letter, so presumably is also the last word in hipness. So, for a while we had the Xbox, the X-Games, and the X-treme everything or the Camaro Z28 . Sometimes the X hung out with a Z, as in the Kawaski ZX series of motorcycles or the Mazda ZX7. You can’t be too hip, after all.

Right now, of course, we’re in the “i” era, as in the iPhone, iPod, iPad, iTunes and iMac. And there is a real flood of businesses that don’t have anything to do with computers that are tacking that little lower-case vowel on the front of their names.

Ironically, Apple itself is harking back to an earlier era with its iWork software. Here comes that work thing again.

I guess the really great naming strategies never die. They just go through a renewal and recycling period and emerge again, eventually, newly hip and full of dynamic meaning. Or seeming to.

But don’t worry. Cabot has been Cabot for more than 40 years, and I don’t think we’re likely to turn out an InvestmentWorks newsletter, an Investment ZX publication or an iInvest advisory.

The name is Cabot, Cabot Heritage. And we don’t have a 00 prefix.
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As the popularity of mobile phones swelled in China back in the 2000s, so did the temptation on the part of hackers to start spamming and stealing data.

So, in accord with the law that says a big need will sooner or later spawn a solution, NetQin (NQ) sprang into existence in 2005. The company specializes in software for mobile devices that protects them from malware and data theft, and the recent results have been spectacular. The company booked its first profit in Q1 2010, and its three latest quarters have featured earnings growth of 600% (Q1 2011), 800% and 275% (Q3 2011). Revenues, meanwhile, have recorded seven quarters of triple-digit growth.

The company is adding data synchronization and cloud services to its roster, which should prove appealing to consumers.

But the real change that has attracted my attention is the company’s hiring of Omar Khan to serve as co-CEO with Chairman and CEO Dr. Henry Lin. Khan arrives from Citigroup, where he headed the company’s mobile development and delivery campaign. Before that, he was a key player at Samsung Mobile and Motorola. Khan is an MIT grad with “mover and shaker” written all over him.

Khan’s significance lies with NetQin’s global expansion program, which is targeting North and South America, Europe, Japan, Korea and India. All of these areas are heavy mobile usage zones, and the attractiveness of NetQin’s services could prove substantial. The company will be rebranding itself NQ Mobile for international purposes, just so consumers won’t have to suffer through puzzling out the Chinese name (which is pronounced Net Chin).

NQ came public in May, and quickly drooped from its IPO price of $11.50 to as low as 3 in early October. The action since then has been wild and wooly, but January brought a wave of high-volume buying that pushed the stock back to 8 before it calmed down and put in a tight two-week base at 7. The hiring news is igniting interest again.

NQ is still pretty speculative, trading at a thin 225,000 shares a day and showing some big volatility. But it’s also a big story, and one that could become attractive to many institutional investors once the stock cracks into double figures. I have it on my watch list, and I think it would pay you to give it a look-see.

Oh, and just by the way, while spirits are a little low here at Cabot following the Patriots loss in the Super Bowl, nobody is on suicide watch, and we expect to recover just fine, thanks.

Sincerely,

Paul Goodwin
Editor of Cabot China & Emerging Markets Report

Paul Goodwin is a news writer for Cabot’s free e-newsletter, Wall Street’s Best Daily.