Lack of Entrepreneurship, IPOs
The Message: Go with the Elephants
As a student of the market, I learned in my early days was that market leadership usually switches from cycle to cycle. That is, during one full bull market—usually lasting three or four years—you usually have one set of leaders from two or three different industries. These industries, of course, are usually the ones with unique, revolutionary products and services that are driving the economy forward during that time … and the companies themselves lead the way.
Eventually, the bull dies and a bear market begins, and the leaders generally fall to earth after becoming “over-owned” by the institutional crowd, and after years of rapid growth, the companies begin to slow down or—possibly because of competition, too-fast expansion, poor management or simply a bad economy—actually shrink. Believe it or not, the average decline for a big winner after its ultimate top is 72%. It’s true!
Following the bear market, of course, comes another bull phase, and this is where market leadership changes. The reason isn’t magical; it’s simply that there are usually different young growth drivers for the next expansion, and the individual companies that are leading the new trends put on the best show during the bull phase.
In one cycle, for instance, it might be high-tech plays that are boosting productivity. The next, it might be entertainment and consumer-related plays that lead the way higher. The next might be some new industry or technology (like solar energy in 2007). And so on.
Thus, leadership shifts from cycle to cycle—the “over-owned” stocks might rally during the next bull market, but they don’t resume their leadership position. The classic example of this was Cisco, JDS Uniphase, Nortel and countless other networking plays during the late-1990s bubble. Cisco, for instance, hit a peak of 82 in March 2000, then fell as low as 8 in 2002. Its highest price since then has been just 34 (reached in late 2007), despite the fact that earnings this year are actually three times as high as the company achieved in 2000! And the tales of woe are even worse for JDS Uniphase and Nortel, which have barely gotten off their knees during the past few years.
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Wall Street’s Next Big Shocker
With unemployment rising and real estate prices spiraling south, it’s clear that the market’s volatility is about to increase exponentially—especially headed into the November elections.
For these reasons, the next market move we see headed our way in the next 30 days could be the biggest shocker of 2010. My free report reveals what you must do now to protect yourself and profit. Get the free special report!
So why am I writing about historical trends in leadership and how it changes from cycle to cycle? For one main reason: Because in this bull move that began in March 2009, the opposite has occurred!! That’s right—we’ve noticed that many of the leaders of the last bull market (2003-2007) have regained their leadership positions. It’s highly unusual … but that doesn’t mean it’s wrong.
One obvious example is Apple (AAPL), which originally broke out back in the summer of 2004. (Cabot Market Letter recommended shares in early September of that year, after the market’s mid-year correction ended.) The stock had a huge run from a split-adjusted 18 to a high of 202 in 2007. And then, just as most big leaders do, it fell to 78 during the bear market … a drop of 61%. However, instead of languishing, Apple has been a mega-cap leader of this bull market, recently moving back into all-time high territory.
We’ve seen similar action with Baidu, Priceline.com, Netflix and other leaders—all these stocks put on great performances during the last bull market, yet they’ve also helped lead this bull market higher.
Why is this happening? I think there are a couple of reasons that. First and foremost, new leadership often comes from new ideas, new products … and new stocks. Most often it’s companies that just came public during the prior year or two that have revolutionary products and cutting-edge technology that morph into leaders, as institutional investors build positions over many months.
Yet during the past decade, public offerings have been relatively scarce … and during the past three years, they’ve been really scarce. In fact, the number of initial public offerings from 2008 through today is actually less than was seen in the single year in 2007. This scarcity of IPOs has really cut down on the pool of new potential leadership.
Also, on a more fundamental note, the lack of new company formation in the U.S. as a whole during the past few years likely means that the top talent—product developers, marketers, big-idea type of thinkers—are being hoarded by the top companies. And that’s why these companies are able to re-invent themselves every few years, which helps growth remain robust and stock prices trending higher.
Apple, for instance, became a leader with the iPod and iTunes, but today, that business is mature. Now Apple has moved on to the iPhone and iPad, which are big hits.
Movie rental service Netflix (NFLX) made hay by crushing Blockbuster with its DVD-by-mail business. But now Netflix management says that, in the fourth quarter, it will deliver more movies online than by mail!
Priceline (PCLN) took off in the U.S. with its “Name Your Own Price” feature, but recently, its growth has been driven by its hotels.com site, which is the largest hotel booking site in Europe.
I could go on, but the point is that, in the current bull market, many of the true institutional-quality leading stocks were leaders of the last cycle … benefiting now from top management and (usually) some new product or service that is reinvigorating growth.
Another example of this is NetApp (NTAP), formerly known as Network Appliance, which is positioning itself as the King of Storage. Yes, EMC and others are still ultra-competitive in this field, but NetApp seems best able to serve the needs of large corporations as they move toward cloud computing. Here’s what I wrote about NetApp in Cabot Top Ten Weekly back on September 13:
“On one hand, NetApp is a data storage company, and we know from experience that data storage stocks that fly to the sun often crash and burn. On the other hand, NetApp is at the heart of the biggest driving force of information technology buying today, the move to cloud computing. As this movement evolves, more and more institutions and individuals are finding that they can lower costs and increase productivity by storing their data somewhere in the cloud, and by using applications that are hosted in the cloud. And the simple fact is that no one knows how far this trend will go. As students of trend analysis, we know that trends typically go further than people expect, and thus we think the movement toward cloud computing—and NetApp—can go very far indeed. Revenues at the company have grown every year of the past decade, while earnings have grown every year save for 2009, and now earnings are roaring back. Profit margins in the second quarter were the highest in more than three years!”
The stock is very liquid (it trades eight million shares per day and the stock is priced in the low 50s), has good institutional support, and has been one of the leaders of the recent advance. Earnings are due out around November 17, which poses a risk, but I think buying a small position on any dip of a couple of points is worth it. NetApp offers opportunity as another bigger firm that has re-established itself as a leader during this bull cycle.
Learn more about NetApp and other leading stocks in Cabot Top Ten Weekly.
Until next time,
For Cabot Wealth Advisory