Is this a Bear Market? A Correction?
What to do if You Own a Slew of Broken Stocks
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Every few months I like to put together a frequently asked questions issue of Cabot Wealth Advisory, and I try to do it at a time when the market is even more confusing, volatile and frustrating than normal. So now is the perfect time!
I'm attempting to hit on a few common questions (and, usually, misperceptions) that can help you better understand how the market actually works, which, in turn, will help you make (and keep) more of your money. Some of the questions are market-based, some pertain to individual stocks, but all of them should help you become a better investor.
So, without further ado ...
Question: You look for stocks that have held up the best during the market downturns, saying they'll be the ones that do best once the bulls return. But what about good companies whose stocks are beaten down?
Answer: There are really two answers to this question. In general, yes, if a stock has a great growth story and can't go down much when the market is heading south, think of it like a coiled spring--it wants to go higher, but the weight of the market is on top of it. Once that weight is relieved (i.e., a new market rally), the stock will spring higher, oftentimes in a hurry.
Yes, the stock that falls 30% or more during a correction will probably have a snapback rally, but unless the stock has formed a bottoming pattern--something that usually takes many weeks--there will be many investors who own that broken stock at higher prices who will be looking to sell as the stock rallies ... and that selling will slow down or stop any attempted advance.
More important, though, is that you have to decide what kind of investor you are. I'm sure it's possible to make money buying beaten-down stocks, but that is not my style. I simply know there are plenty of good opportunities in stocks that hold up well during a market decline, including many that turn into great winners. In other words, I'm not saying my way is the only way, only that I know it's worked for decades at Cabot.
Question: You often write about buying on weakness, but I've found that when a market begins a new rally, many of these resilient stocks (that didn't fall much during the correction) are extended well above support and key moving averages. So should I try to buy these names on weakness when the market turns up?
Answer: This is a great question and is a perfect example of how, in the stock market, there are no absolutes. Yes, during 80% of a market cycle, it's usually better to buy stocks that are either pulling back normally toward some support (like the 25-day or 50-day moving average) or decisively breaking out of a well-formed basing structure.
However, when the market has come through a multi-week correction and just confirmed a new uptrend, you're almost always better off just buying the strongest growth-oriented stocks around. Assuming the market's new rally is the real McCoy, it's likely that there are tons of mutual, hedge and pension funds all trying to establish positions in the market's new leaders. The result? Little in the way of pullbacks for the first two to four weeks.
That's not to say you shouldn't adhere to your loss-cutting rules in case something goes awry, but at least for your first couple of purchases, buying the most resilient growth stocks (not defensive stocks like gold or food) as soon as the market gets going is usually a good bet.
Question: I've been watching XYZ stock; it's got all the attributes you look for. And it's held up well during this decline. Can I buy some now?
Answer: Doing a little new buying during this correction is fine by me, but just remember that, in a bad market, good stocks can go bad in a hurry. Thus, today's strong stock could crumble before the downturn ends.
Question (follow-up): That makes sense, but what if I wait for a stock to break to new highs?
Answer: Again, it's OK to nibble and possibly get started on a position ahead of time. But most breakouts in bad markets do not work. Actually, that's one of my subjective indicators that a correction is over--when a potential leading stock or two break out on big volume, hold those gains, and then continue higher. But the odds favor breakouts failing (sometimes in a hurry) if the trend is down.
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Question: Some pundits are saying this is a new bear market. Others are saying it's a correction. Others are even saying we're in a long-term bear market that started in 2000 or 2007. What's your view?
Answer: What I think is that labels are totally, 100% overrated. The major question is this: Is the market environment conducive to buying leading growth stocks? If it is, then I'm buying. If it's not, then I'm defensive. It really is that simple. Right now, the sellers are in control, so I'm waiting patiently until that changes.
As for all the cyclical bull, secular bear, etc., I advise you to just hit the mute button when you hear that stuff. Supposedly we've been in a long-term bear market since 2000, but that didn't stop investors from making good money during the upmove from 2003-2007 in stocks like XM Satellite Radio, eResearch, eBay, Yahoo!, Taser, Google, Apple, Southwestern Energy, First Solar and Crocs, just to name a few. Heck, even during the early stages of the 2007-2009 bear market, there were opportunities in stocks like Visa and Continental Resources. Thus, let the pundits debate the labels of the market. Your job is to size up the market's current trend and position yourself accordingly.
(For the record, some of the indicators I follow do suggest this is "just" a correction, not a bear market--but that didn't stop me from advising my subscribers to move heavily into cash three weeks ago.)
Question: Mike, I respect your indicators and your work, however, what is going to turn this market around? A resolution in Europe? Another financial bailout? What?
Answer: I have no idea, and neither does anyone else. But the good news is that you don't have to know what will turn the market around--all you need to do is to watch the market's actions. It will tell you when it's ready to head higher.
As a brief example, can you tell me what ended the market's 10% correction in early February? And, for that matter, what caused it to top out in January? Anyone? My point is that the supposed reasons for an advance, decline or turning point aren't that important. Just stick to the market's message.
Question: Whenever the market's turn comes, how will you know it's the real deal? It seems there are so many promising upmoves that turn into dust within a day or two.
Answer: Well, first, we have a market timing system at Cabot that treats us well. It's not perfect (no system is), but when our Cabot Tides (intermediate-term trend following indicator) turns positive, that will give the best thumbs up that the rally is for real.
Beyond that, however, the real key I've found is your own portfolio--specifically, your portfolio's balance. Are you making money with your purchases? Are your stocks heading higher with shallow pullbacks? Are your new purchases getting off to good starts? If the answers are yes, then the odds are strong that the rally is for real.
If, however, you buy a couple of stocks and they head south, and then you maybe buy one more, only to see that struggle, then your antennae should be up--no matter what the market timing says, if you can't make money on your first handful of purchases, it's possible the market isn't as strong as it appears.
Long story short, you want the market to "pull" you into a heavily invested position after the trend turns up. And you get pulled in by getting off to good starts on your first few purchases.
Question: I still own a lot of stocks that have broken down badly. I guess I should sell them, but they're good companies, and the market is already down so much. What should I do?
Answer: This is probably the most common question I'm getting these days. And I do agree that selling a ton of stocks right now, after the market has fallen more than 10% in just a few weeks, isn't likely the best course of action.
That said, doing nothing and simply hoping your stocks and the market turns around isn't prudent, either.
So my answer is to split the difference--take some action now by selling a portion of your losers. This will do two things. First, it will get you back in gear with your stocks; you're selling shares because of the evidence in front of you. And second, it will get you into a proactive mode; you're not waiting and praying for help, you're examining the situation and reacting to it
Then, with the rest of your shares, you should formulate a reasonable game plan on how you want to sell the rest of your shares (hopefully after a few days of rallying). Chances are your broken stocks will not be leaders of the next advance, so you're better off coming up with an exit plan so your money can be better invested elsewhere when the bulls return.
Question: I've heard Cabot does a good job of timing the market. My question isn't what you think of the market, but what is the basis of the system you use to time the market?
Answer: The main focus of our market timing is trend following--we generally look at the major indexes in relation to some key moving averages. If the indexes are above their moving averages, and the moving averages themselves are heading up, we consider the trend to be up. If the indexes are below the moving averages, the trend is down.
Using a trend-following approach can be mentally difficult because it requires you to put your pundit hat off to the side, swallow your ego and any opinions you have, and simply listen to the message of the market. But it provides us with a major advantage: We are guaranteed (yes, guaranteed) never to miss out on a major, prolonged market upmove, and we're guaranteed never to remain heavily invested during a punishing, sustained bear move.
Of course, sometimes there will be whipsaws (signals that are quickly reversed), but that is a very small price to pay for knowing that you'll always be on the right side of the market's major trend. Whether it's our system or one you develop on your own, I strongly suggest you develop a way to spot major trend changes--it's sure to significantly boost your results.
That's all the time I have for now.
All the best,
Editor's Note: If you want more of Mike Cintolo's expert growth stock picking and market timing advice, you should check out Cabot Market Letter today. It uses a system perfected over 40 years to get investors into the top growth stocks when the market is healthy and get subscribers safely on the sidelines when the market turns ugly. Don't miss another signal. Click below to get started today!