Stock Selection and Flexibility are the Keys

 

We are trend followers at heart, because in the long run, that’s the way to make big money. After all, trends often go to extremes, lasting longer and traveling farther than anyone expects. And if you can catch one good bull market—and a couple of big leaders of that bull market—you can make a material difference in your life.

On the flip side, we’re obviously not big fans of downtrends, but given our market timing, we simply stay defensive (heavily in cash) during prolonged declines, preserving our capital and waiting patiently for the next buy signal.

But choppy markets are a hassle. In choppy environments, many stocks are rising, many are falling, and rotation (money switching from one group to another) is vicious. That’s the environment we’re in today, especially for U.S. markets (the S&P 500 has traded within a couple percent of where it started 2015 nearly all year), but also in emerging markets, which have seen their share of divergent action.

The keys to success in this environment, as we write in the title, are stock selection and flexibility. Of course, these traits are always important in investing, but doubly so when the environment is so mixed.

Stock selection speaks for itself. Now is the time when being able to home in on the big leading stocks—those with the best stories, growth numbers, future potential and, importantly, sponsorship—pays off. You want to find stocks that have a degree of safety to them, but also have a chance to push ahead even as the benchmark indexes struggle. Knock on wood, but so far, we’ve found many stocks to like during this rally, and they’ve held up relatively well even during last week’s selling wave.

Equally important is flexibility, otherwise known in the market as “leaving your ego at the door.” The past few months have seen more sudden ups and downs in individual stocks and sectors than we can ever remember.  Yes, earnings season always produces some shockwaves, but this year we’ve seen entire industries get taken out and shot within a few days; last week’s destruction of retail stocks was the latest example.  

Now, taken to the extreme, flexibility can be a bad thing. In fact, during last week’s selling wave, we heard from many investors who bailed out of a few stocks simply because they had a couple of bad days. Maybe that ends up being the right move, but you still want to have a plan and (importantly!) follow that plan, such as holding stocks that remain in uptrends.

The bigger point is that all of the market’s ups and downs require you to take an unbiased look at your stocks (as well as the ones you’re watching for purchases) every few days. And when the trends break down, it’s important to get out!

Putting it together, we’re trading the best and leaving the rest (stock selection), while also having mental stops on most of our holdings, even if they’re acting well today (flexibility). And we’re also keeping a close eye on the Emerging Markets Timer, which is on the fence (like so many stocks) to guide our exposure.

The good news is that “trading the best” isn’t incredibly difficult these days. As we mentioned above, many emerging market stocks have great stories and good sales and earnings growth, which should keep growth humming for many quarters or years. Our recommendation in this issue is an old friend that fills the bill, thanks to a tremendously bullish catalyst for the years ahead.


This is an excerpt from Cabot Emerging Markets Investor, which seeks to capitalize on the enormous potential in emerging market countries. Chief Analyst Paul Goodwin has been a researcher and writer for over 30 years and a member of the Cabot investment team since 2005.

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Paul Goodwin can be found on Google Plus.

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