The Market’s at New Highs—So Now What?

 

The Market’s at New Highs—So Now What?

Buying at New Highs or After Corrections

A Potentially Explosive Stock

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I read a newspaper story on June 2 that laid out the situation pretty clearly. It said: "High unemployment. Lackluster economic growth. Deep federal budget cuts. A new banking crisis in Europe. None of that has put much of a damper on stock markets."

Well, yes and no.

It's true that the Dow has soared from 6,547 in March 2009 to over 15,200 last Friday. And on that day, the S&P 500 closed at 1,643, topping its highs from March 2000 (just before the Tech Bubble self-destructed) and October 2007 (just before the Housing Bubble imploded).

The problem is that many individual investors are having a hard time deciding when (or whether) to jump back into the market. They can't figure out if having the stock market at new highs is a good thing (Yay, momentum!) or a bad thing. (Look at what happened the last time markets were at these levels).

I wish I had an unequivocal answer.

Unfortunately, decisions about when to buy are just as difficult as decisions about what to buy. And these decisions are also highly personal.

For my own buying, I'm happy to buy a stock at a new high. I'm a believer in the maxim that the most bullish thing a stock can do is go up. My second-most favored strategy is to buy a great stock after what looks to me like an undeservedly severe correction.

On the other hand, a chart reader like Mike Cintolo, while liking new highs as much as anyone, favors buying breakouts from flat bases and longer consolidations. Technically, I know he's got history on his side. But actually pulling the trigger on a new position is too personal (and emotional) a decision to make by someone else's rules.

I hope that doesn't sound odd, coming from someone who works at Cabot. Our growth investing letters are full of rules for picking, buying and selling stocks, and will tell you how to put together a portfolio of great growth stocks and how to stay in step with the investing climate of the market. That covers 90% of the investment decision.

My point is that if you don't FEEL right about an investing decision, it's unlikely that you will follow the rules well enough to succeed. Knowing your own investment style is not just a hypothetical, New Age good idea, it's a basic building block of investment success.

Mike and I agree on many things about growth investing. Some I have learned on my own, some I've picked up from nearly 10 years of working at Cabot. And some have been taught to me by the market through unpleasant (and expensive) experience.

For instance, I now understand that, if you're just starting out, buying only one stock is riskier than buying several. I now know not to hold my losers past my maximum loss limit. (I’d hate to tell you how expensive that lesson was.)

And I now take very, very seriously the idea of keeping my buying and selling in step with the market. If you're the captain of a small boat, you don't set sail during a gale. If you're piloting a small plane, you know enough to keep the chocks on during a storm. And if you're a growth investor, you keep your wallet in your pocket when the market is in a downtrend.

Conversely, however, when the weather is good, you’d better be sailing or flying or whatever metaphor for buying stocks you prefer.

And that brings me back to the beginning of this piece, when I was pointing out that the markets are at new highs.

If the only thought you get from seeing that stock markets are doing very well is a glum premonition that they will soon be heading down, you need to re-tune your perceptions. While a correction is always a possibility, a bull market is a fact. And it’s a fact you need to take seriously.

Bull markets are too rare to let them go to waste.

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My stock for the day is no stranger to anyone with a passing interest in emerging market stocks. It’s Baidu (BIDU), the dominant Internet search engine in China, and still a potentially explosive stock. But it’s no slam dunk.

BIDU was one of the hero stocks of the late naughts, streaking from 10 in early 2009 to 166 in July 2011.

Baidu’s story is a great illustration of the truism that when everything is perfect, anything that changes is something gone wrong. But it’s not easy to figure out exactly what Baidu did that qualified as wrong.

In 2009, the year Baidu began its amazing run, the company experienced a 40% jump in revenue. In 2010, that rose to 81% growth. And in 2011, the year that Baidu’s stock began its long swoon, revenue growth rose again, this time to 92%!

Earnings were also very strong, stepping up from 66 cents per share in 2009 to $1.55 in 2010 to $3.03 in 2011 and $4.84 in 2012. Lots of companies would be thrilled to have numbers like that.

So why did BIDU, a paragon of revenue and earnings growth and the 800-pound gorilla of the Chinese search market, experience a nasty bumping correction that had it trading at 83 on April 5? Part of the blame goes to investors’ perceptions of China, which refuses to allow U.S. regulators to examine the books of Chinese companies. Some of it can be traced to the back-door listing scandals and reporting irregularities on the part of a few Chinese companies.

Another big reason for BIDU’s fall is investor fatigue. The stock went up until there weren’t any more buyers left, which meant that it had to come down. Valuations got high and the company missed analysts’ consensus numbers in a couple of quarterly reports.

The stock also got dinged last summer when Qihoo 360 (QIHU), an upstart mobile security company, suddenly nabbed a 10% share of the mobile search business in China. The market share came mostly from Google, not Baidu, but it put a dent in the perception that Baidu owned the market, and that’s never a good thing.

BIDU has made good progress since its April bottom. It’s now trading over 100 and buyers have even spiked its volume up a bit.

At a reasonable (but not cheap) P/E ratio of 21, the stock is showing some muscle.

I know from looking at institutional sponsorship that BIDU is still a part of virtually every portfolio that allows exposure to emerging market stocks. Baidu is considered a market leader and BIDU is a core holding for any long-term buyer of emerging issues.

Do I recommend it for you? Well, I think a small buy with a long investment horizon (at least a year) makes a great deal of sense.

Try to get in under 100 and keep an eye on the stock in late July when Q2 earnings results come in.

Sincerely,

Paul Goodwin
Editor of Cabot Wealth Advisory
and Cabot China & Emerging Markets Report

Related Articles:

The High Price of Avoiding Risk


Paul Goodwin can be found on Google Plus.

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