How to Deal with What-Ifs
An Under-the-Radar Stock
Precedent analysis is an interesting activity if you're a student of the market. Most investors, of course, remember little beyond last week, never mind last decade, but here at Cabot, we put a lot of time in reviewing and remembering the past, the psychological pull of many major events and how the market reacted. It can be useful as a loose guide to the current environment.
So what does today compare to? Well, let's examine the evidence. We have a market that suffered a historic crash a couple of years ago, then recovered in equally historic fashion. About two-and-a-half years after the bottom in March 2009, though, the market suffered another break, with the major indexes down about 20% and the average stock off 30% or so.
Following a few weeks of selling pressure, the market has begun to rise ... though it's been choppy and slow going, especially among leading stocks--there still has yet to be much money made on the long side during this rally. Fundamentally, fears of recession are in the air, and the market has been unable to get going because of major economic uncertainties in Europe.
Looking back in time, I found a surprising comparison--1990. Starting from the beginning, you had the crash of 1987, followed by a recovery phase of more than two years. But then, in the middle of 1990, the market fell off a cliff, as what was a normal correction morphed into a brief, punishing bear phase because of Iraq's invasion of Kuwait.
The market actually bottomed in October 1990, but, as you can see from the chart below, the Dow made little net progress during the next two or three months--there was some upside into the end of the year, but lots of choppiness and then a big shakeout to start 1991. The reason: Few investors wanted to place major bets ahead of the likely war, as Iraq's army was the fourth largest in the world back then. No one knew if this was going to be a year-long slog or a quick battle.
Once the U.S. and its allies began dropping bombs, it was quickly apparent that the battle would be over quickly, with little lost in the way of money and lives. In other words, the tremendous uncertainty that had hovered over the market for months finally parted. And you can see the result--the Dow soared, kicking off a huge bull run.
I think there's a loose parallel between late-1990 and the current market. The peak of selling pressures is in the rearview mirror (two huge selling waves in August and October, each causing more than 1,200 stocks to hit new lows, an extreme level), but the uncertainties out there--especially Europe, which is in the headlines literally every day--seem to be keeping a lid on the market and many stocks.
My guess is that, once the uncertainties are lifted, the market and many stocks have some real upside ahead of them. Maybe that will take another two months, or maybe it happens in a week or two; nobody knows. But if and when Europe gets its act together, the bulls are likely to flex their muscle.
Now, let me say this one thing: Precedent analysis is useful to give you a bigger-picture perspective. But, obviously, no two markets are exactly alike, and you have to put most of your emphasis on the price/volume action of the market and leading stocks. For instance, if I see the market begin to unravel for a few days on huge volume, I am going to advise raising even more cash than I have right now--precedent or not.
Still, net-net, I do think the comparison to the post-bottom market of 1990 is apt, and that some clarity to the uncertain Europe situation is all that's needed for institutional investors--the ones that really drive stocks--to begin a powerful new buying spree.
Speaking of uncertainties, I've been getting quite a few emails from subscribers that ask my opinion about someone else's opinion. For instance, I've gotten some comments like this: "Hey Mike, what do you think of the following article? So-and-so seems to think that Italy's escalating bond yields mean they're set to default, which will bring down the whole Euro zone."
My answer, as usual, is that while I'm aware of the news and the goings on in the world, I really try to stick to the action of the market (via Cabot indictors) and leading stocks. They'll tell me if the world is going back in the tank or not.
Right now, though, I have to say this: Trouble usually comes from where you least expect it. That doesn't mean the market can't go down because of Europe; anything is possible, and I am open to any possibility. But the potential pitfalls from that continent are so well known to even the novice investor that I would be surprised if it were the reason for a new leg down to or below the market's October lows.
One thing I am definitely not getting are emails from subscribers citing articles that claim the Dow is heading to 15,000, or that a new bull market is about to blast-off. Or emails asking about speculative low-priced stocks that have already tripled and wondering if they should be bought right now.
In other words, while I wouldn't say fear is at a crescendo (it was back in early October, but it's dissipated since), fear is still at the forefront of investors' minds--everyone is making sure they don't have too much risk, are positioned lightly, etc.
Greed, on the other hand, is hard to find; I seriously cannot remember the last article or email I've seen that urged readers to take a big chance. Instead, I still read about caution and finding "the best" income investments that yield 2% or something.
Thus, count this as just one more reminder to take your cues from the market itself and not to be swayed by others' opinions. Again, I am far from being all-out bullish--if anything, I would call myself cautiously optimistic--but if the market really is going to go over the falls again, you'll see it first through the price/volume action of the major indexes and leading stocks. Wednesday's action, for instance, was a warning shot, but the market and most leaders are still within the trading ranges they've established in recent weeks.
As for my stock idea today, I'm going to venture into an industry that few investors really get excited about--aerospace. I have always had a small affinity towards the group because (a) it's a huge group, moneywise, and (b) there are few firms involved in it. And that means when business turns up, whether it's thanks to the economy or a new product, all of that money flows to relatively few companies.
I believe that's happening now, as a multi-year wave of orders thanks to expansion in the emerging markets (where air travel is growing nicely) and thanks to Boeing's new 787 Dreamliner, which is finally on track after years of delays.
One company benefiting from all this is Hexcel (HXL), a parts maker for the group. Here's what I wrote about the company in the October 17 issue of Cabot Top Ten Trader:
"Aerospace stocks rarely get the blood pumping, but we've always liked the sector because there are so few players in the space ... so when business trends are good, institutional money tends to fly into the handful of firms that are benefiting. Hexcel is one of those firms, specializing in lightweight, high-performance structural materials that are mostly used in aerospace, though the firm also does a decent business in the industrial sector. But the growth is likely to come from increased airplane build rates in the quarters ahead; Boeing, for instance, recently delivered its first 787 Dreamliner (a mere three years late!), and as that program ramps, it could be a boon to Hexcel. (The company reportedly has about $1.5 million of composite materials on every 787.) Revenues have been steadily expanding since a dry spell during 2008 and early 2009, while earnings have been lifting off at a much faster clip. Earnings are projected to rise only 18% in 2012, but we feel that figure will be low, especially if Boeing keeps its act together with Dreamliner deliveries. It's not going to be your fastest horse, but Hexcel looks to be in the right place at the right time."
Since then, the company has reported a terrific third quarter, with earnings of 34 cents per share, trouncing estimates of 27 cents, while revenues leaped 19% from the year before (though revenues were up 32% in its commercial plane segment). HXL reacted well to the news, briefly tapping new-high ground before backing off and chopping around, just like the overall market. I was encouraged to see the stock back off on light volume yesterday as the Dow tanked nearly 400 points.
Still, I think the company's steady business and outlook means the next big move is likely up. I think taking a small position around here makes sense, with a stop-loss around 21. A break above 26 (accompanied by a healthier overall stock market) would be highly bullish.
All the best,
Editor of Cabot Market Letter
Editor's Note: Some investors can make good money in bull markets, and some are good at avoiding damage in bear markets. But to have great returns, you need to do both ... like Mike Cintolo (VP of Investments for Cabot) has done as editor of the Cabot Market Letter. Since he took over at the start of 2007, Mike has outperformed the S&P 500 by 11.0% annually thanks to top-notch stock picking and market timing. To benefit from Mike's advice during these challenging times--and to know when and what to jump on when the bulls re-take control--be sure to give Cabot Market Letter a try today. Click here to learn more.