How Cabot Trend Lines, Cabot Tides and the 7.5% Rule Keep You on the Right Side of Every Market
If you’ve heard it once from the financial experts, you’ve heard it a million times—it’s impossible to time the stock market, and anyone who tries ends up with poor results. Of course, these people are talking with their wallet, as the money you keep in their mutual funds, the greater the management fees they collect.
The good news is that you CAN time the stock market. How do I know? Because, at Cabot, we’ve been doing it for more than 40 years! And to be honest, it’s not nearly as difficult as most investors believe—all you need are some simple rules and the willingness to follow them.
In this report, I discuss two types of market timing indicators we follow. Our trend-following measures (which provide guidance for our current market stance), and “blastoff” indicators (which flash rarely, but when they do, point to significant gains ahead).
Trend-Following Measures
The key to market timing is to pay attention to the market itself. If you’re always focusing on valuation, interest rates, currency movements or oil prices, you won’t get it right. Trust me—when I first came to Cabot in 1999, I literally tested (and invented!) dozens of indicators, each one focused on something different. The results were mediocre at best.
But then, one day, I simply overlaid the returns from our portfolio with a chart of the market—not surprisingly, our performance dips all came when the market hit a serious pothole, and the big upmoves came when the market was kiting higher. Obvious, right? But we figured, if this is the case, why don’t we throw most of the other, secondary indicators overboard and focus on the market’s actual trend?
That’s just what we did, and it’s why we’ve frequently been cited as among the top market timers in the country by Timer Digest (the keeper of the keys for market timing advisories).
Our stalwart trend-following indicator is called the Cabot Trend Lines, and a version of it has appeared in every issue of Cabot Growth Investor since we launched in 1970. Here’s how it works:
At the end of every week, we compare the S&P 500 and the Nasdaq Composite to their 35-week moving averages. If both indexes are above their respective 35-week lines for two straight weeks, we get a Buy signal. And we stay on the Buy signal until both indexes close two straight weeks below their respective moving averages.
Simple, right? Yep. And it works! If you followed the Cabot Trend Lines since 2000, you’d be up 175%, compared to the Nasdaq’s 70% gain. Not bad!
Probably more important, you would have basically avoided both major bear markets of the 2000s—the Trend Lines were bearish for all but six weeks from October 2000 through April 2003 (the Nasdaq was down 48% during that stretch), and the Trend Lines were bearish the entire time from January 2008 through May 2009 (the Nasdaq was down 28% during that stretch).
And note that the Buy signals came just a month or so after these major bottoms, so we didn’t sit on the sideline for years like so many investors did after the carnage ended.
Of course, the Cabot Trend Lines are longer-term, so we do have another trend-following indicator that tells us the intermediate-term trend (we call it the Cabot Tides), helping us better pinpoint entry and exit points during the market’s corrections and consolidations.
Together, the Cabot Trend Lines and Cabot Tides are in every issue of Cabot Growth Investor and are the most important factor in determining our overall market stance.
Blastoff Indicators
We also like to keep what we call Blastoff Indicators on our radar screen—these are measures that flash very rarely (once every two or three years, and sometimes just once every decade or so), but when they do, they portend much higher prices in the months ahead.
We follow many Blastoff Indicators, but the one I’ll describe today is the one that flashed in February 2016. We call it our 7.5% Rule and it’s linked to the Cabot Trend Lines.
Here’s how it works: When the S&P 500 rises to at least 7.5% above its 35-week moving average for the first time in at least nine months, it’s a Buy signal.
Since 1980, the 7.5% Rule has given about 10 signals (about once every four years or so). Three months later, the index was up an average of 5%; six months later, up 9.2%; and a year later, the S&P was up 15.4%. Moreover, the index notched an average gain of 21% sometime during the following year.
Plus, we were struck by the lack of pullbacks that generally occurred after each signal—the average maximum drop from where the signal flashed during the ensuing year was just 2.5%! Of course, sometimes there were steeper retreats (2009’s super-volatile market pulled back more than 7% before exploding higher), but other times, there was no pullback at all.
Conclusion
The bottom line is that, contrary to popular thinking, you absolutely can time the market—avoiding big bear markets and getting back in early in bull markets isn’t hard to do with a simple trend-following indicator like the Cabot Trend Lines. Nor is identifying when the market is showing unusual upside power that should lead to further gains in the months ahead, like the 7.5% Rule.
The key is that you need to know what to look for and you need to follow the rules! In Cabot Growth Investor, we’ve used these time-tested measures to wade through the market’s ups and downs for more than four decades, and we’re here to help.