The Big (Wrong) Market Question: WHY?

 

Stock Market Video

The Big (Wrong) Market Question: WHY?

This Week’s Fortune Cookie

In Case You Missed It

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In this week’s Stock Market Video, I look at the market’s puzzling behavior, as the broad market is trading sideways with a little added volatility but many leading growth stocks are getting clobbered. Whatever the reason for this behavior—profit taking, flight to safety trades, etc.—you should be keeping your growth holdings on pretty tight leashes. Pay special attention to how your stocks hold up at the 25- and 50-day moving averages and whether they are finding support at appropriate technical levels. I also point out a number of stocks that are either ignoring the undertow in growth stocks or are actually making progress. Click below to watch the video. 

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The Big (Wrong) Market Question: WHY?

Most investors, at least most successful investors, like to think of themselves as rational people. They look for historical precedents for patterns and watch economic and market data for clues to trends and possible future moves. In other words, we try to get the action of the market (and the stocks we own) to make sense.

For years, before I came to Cabot, one of my responsibilities was to write monthly market summaries for a big Boston investing house. I cast a broad net for information on meetings and interest policies of the Federal Reserve Board, the European Central Bank and the Banks of England and Japan. I scanned purchasing managers’ reports on manufacturing activity and kept tabs on inflation at both producers’ and the consumers’ level, along with import/export balances, unemployment and the national debt. Add in corporate earnings reports, election cycles, weather disasters, wars and holiday sales, and you have a pretty complete picture of the factors that the investing house I was writing for looked to for explanations of market movements. I was good at writing these reports, shaping a sensible narrative out of constantly changing data. The form was always the same:

“This happened and the market went down.” “This other thing happened and the market went up.”

But after nine years of living with stock investing from the bottom up here at Cabot, I now realize that most of what I wrote back then was crap. Pure wishful-thinking crap, at least for individual investors trying to manage a portfolio of individual stocks.

To give the crap an academic name, I was guilty of the post-hoc fallacy, a form of flawed logic that mistakes a link in time for a link in causation. The full fallacy is “post hoc ergo propter hoc,” which means “after this, therefore because of this.” But I digress.

The point is that I’ve spent a lot of time providing answers to the question—sometimes stated, sometimes implicit—WHY is the market doing what it’s doing to me? And I stand here before you today (figuratively) to tell you I’m a changed man.

WHY? is useful only in the sense that it can reinforce your decisions to buy or sell. Otherwise, it’s a trap and an illusion. The only reality is what’s actually happening, especially what’s actually happening with the major market indexes and the prices of your individual stocks. Because that information is something you can actually use to make (and keep) money.

If markets are in a downtrend, you should be taking action to protect your holdings. You should tighten up the loss limits on your growth stocks and limit your new buying. You should consider taking partial profits in the stocks where you’re ahead and tighten your selling trigger finger on stocks that have shown unusual downside volatility, dropping through previous technical support or through 25- and 50-day moving averages.

The takeaway of this rant is that you shouldn’t think about second-guessing the trend. It’s fine to study why the market is acting a particular way, but the bottom line should still be to adhere to your selling rules.

There is one big exception to this rule. (There always is, isn’t there?) If the market is in good shape and most growth stocks are doing well, and one of your stocks suddenly drops like a cannon ball off the Tower of Pisa, it’s a good idea to look for the why. Sometimes a drop will come from a secondary stock offering or a poorly received resignation or a contract miss. Sometimes it’s something even worse, like a whiff of scandal or fraud. And you can use that information to decide whether to stick with a stock or let it go.

But when markets are in as churlish a mood as we’ve seen for the past few weeks, all “WHY?” is going to do for you is ruin your digestion and make you hesitate to take action. And that leads to the general rule out of this screed: “Forget the why; react to the what.”

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Here’s this week’s Fortune Cookie. Remember, you can always view all previous Fortune Cookies here and Contrary Opinion buttons here.

Tim’s Comment: This caution is so obvious to experienced investors as to be unnecessary. Experienced investors know that surprises happen all the time, so they take care to invest moderately, and to diversify their investments. But amateurs enter the market with stars in their eyes, dreaming they'll double their money by buying the next Tesla, and sadly, many of them wind up in Edsels (and Fiskers) instead.

Paul’s Comment: Yes, it’s a bit obvious, but it’s still a good lesson despite the obviousness. Sometimes you have to tell people not to check for piranhas by sticking their hands underwater. And in this kind of market, it’s also a reminder that doing the right thing (in the present case, that means cutting your losses short) is still the right thing to do. Bear markets are not the right time for contrary thinking.

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In case you didn’t get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.

Cabot Wealth Advisory 3/24/14—Calamity is the Touchstone of a Brave Mind

Cabot Stock of the Month Chief Tim Lutts tracks down a fortune cookie quotation (it’s from the Roman stoic philosopher Seneca) and takes a skeptical look at restaurant fortunes as sources of investing (or lottery) advice. Stock discussed: Zulily (ZU). 

Cabot Wealth Advisory 3/25/14—The Greatest Options Trade I Ever Saw

Chief Analyst Jacob Mintz of Cabot Options Trader writes in this issue about a legendary personality in the options trading community. He also describes the greatest options trade he’s ever witnessed. Option discussed: Applied Materials (AMAT)

Cabot Wealth Advisory 3/27/14—Stock Chart Reading II

In this issue, Mike Cintolo, Chief Analyst for Cabot Market Letter and Cabot Top Ten Trader, looks at the question of whether it’s better to buy a stock on strength or weakness. He also shows how to identify bases and breakouts. Stocks discussed: Baker Hughes (BHI), Concho Resources (CXO) and U.S. Silica (SLCA). 

Have a great weekend,

Paul Goodwin
Chief Analyst, Cabot China & Emerging Markers Report
and Editor of Cabot Wealth Advisory


Paul Goodwin can be found on Google Plus.

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