The Perils of a Bull Market

 

The Perils of a Bull Market

What's in a Name?

A Strong Stock Early in its Advance

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When stock markets are declining and investors wish for a rally as eagerly as teenagers wish for summer vacation, it's hard to stay upbeat. Staying upbeat requires patience (which is boring) and discipline (which is difficult). Every stock investor is familiar with the woes and worries of a bear market. When nobody's making money except the short sellers, most of us just curl up into a ball and get depressed.

That's the case even if you follow the Cabot growth investing disciplines, which tell you to cut your losses short, move to cash and work on your watch list. Even if you're not losing money, sitting on the sidelines just isn't much fun.

Right now, when the markets are strong and giving us buy signals in the Cabot Market Letter, a different set of worries shows up. And they're the kinds of problems that aren't obvious when you're wishing for the bulls to take charge.

Here is a short list of the biggest challenges of bull markets, plus a little advice about how to deal with them. (Remember: I'm a growth investor, so this may be a little aggressive for the committed long-term devotee of buy-and-hold value principles.)

Challenge #1: Picking the Stock

When the market is rallying, there are always more attractive targets than your hypothetical portfolio has positions. A quick look at the best charts from January will definitely have your head reeling. So how do you decide which stocks to jump on in such a target-rich environment?

First, you need to get a picture of the perfect stock in your head. You want it to have a chart that shows strong price advances, indicating that it's being bid up by enthusiastic investors. You also want to see rising trading volume, which is often a good indication that institutional investors are in the hunt.

Second, you want to find companies that are achieving bottom-line success, which is indicated by rising revenues and earnings.

Third, you want to find a stock whose story makes sense to you. It should have a product or service that has the potential to reach a much larger population of buyers. This may take the form of a unique technical innovation or a way of cutting costs or an economic trend that will bring buyers around in droves. Be careful here, as the kinds of stories that make great sense at cocktail parties often don't pan out in the real world. If your great story doesn't have the support of good bottom line trends and a rising chart, you should be skeptical.

Challenge #2: Pulling the Trigger

Once you've selected a stock that's hitting on all three of these cylinders, you need to decide when to actually buy it. (Remember that the moment you buy a stock is your moment of maximum exposure, so you need to protect yourself from sudden pullbacks. Stocks that move up quickly can move the other way with equal speed.)

The two classic ways to lower your risk at the moment of purchase are buying on dips and buying partial positions with the intention of averaging up later. You can find all of this growth investment advice on the Cabot website. And, not to sound too salesy, but a subscription to a Cabot growth newsletter like Cabot Market Letter will spare you much of the anxiety that stock selection, buying, selling and portfolio management can cause.

Stocks that are vaulting up the charts will often either correct sharply or trade sideways for a while as they wait for new buyers to push them higher. A dip to the stock's 25-day moving average will often lead to a new advance, and is a fairly reliable buy point. So is a stock's first dip to its 50-day. Watching for these moves and "buying on the dips" can get you into a stock at a useful discount.

The other way to keep your immediate risk down is to buy a smaller position than you typically would. We recommend about half of the usual dollar amount you allocate to each stock.

Challenge #3: Selling

Although it sometimes seems like every stock goes up in a bull market, your rational mind will tell you that's not true. Sometimes it's a bad earnings report that holds your stock below the water line, other times it's profit-taking and sometimes it's just a bad piece of news that affects the whole market.

Whatever the reason, if a growth stock in your portfolio has dropped 20% below your buy price at the close of any trading day, you should consider selling it. That's the essence of the Cabot sell disciplines for growth stocks. (We tighten up that loss limit to 15% when the bears are in charge, but you don't want to think about that now.)

Now listen very closely. This is important. Selling is very, very, very hard to do well. Sometimes you don't want to sell because the stock that has given you a 20% loss is rebounding. Sometimes your loss is just too big, and you tell yourself you'll wait for a rebound. And sometimes you just give up and refuse to think about it.

Here's the big lesson: If you can't bring yourself to cut losses short, you probably can't make money as a growth investor. Growth investors typically make money by finding one or two really great stocks per year and riding them to big gains. This works only if you can prevent the one or two stocks that really tank every year from eating up your profits.

I hope I haven't made growth investing sound too wrought with tension. For an investor with the right temperament, it's actually fun and stimulating, and the returns can be quite rewarding. It's almost like going to Las Vegas, but it's a version of Las Vegas where you can improve your odds by following a few simple rules. The casinos work very hard to be sure you can never get an even break, but the market is a little more forgiving ... if you play by the rules.

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I used to work for a company that (among other things) helped to find names for new companies. So I'm always sensitive to cycles of naming strategies, as it seems that companies looking for a name that communicates their dynamism or their tech savvy go through phases.

So it occurred to me a while back that I hadn't seen any new businesses using "works" in their names any more. That seemed odd, because it used to be one of the most popular suffixes for any business trying to give itself a slightly industrial, artisanal feel.

Heck, I used to work at a small business that was part of the tide (Cineworks, a small film and video production company).

There is still a Boston Beer Works, and a PrintWorks, and a Bavarian Auto Works, and a Body Works gym, etc. But it's not a name out there on the cutting edge any more.

Then I realized that the whole "works" thing had been dead for years, and that naming had been through at least two generations before I noticed.

Some time after the "works" era, there was the "X" and "Z" era with its implications of Xperimental and Xtreme and a letter that was made hip by Zorro. The X reached back to both X-rays and the X- series of aircraft and the Z is the last letter, so presumably is also the last word in hipness. So, for a while we had the Xbox, the X-Games, and the X-treme everything or the Camaro Z28 . Sometimes the X hung out with a Z, as in the Kawasaki ZX series of motorcycles or the Mazda ZX7. You can't be too hip, after all.

Right now, of course, we're in the "i" era, as in the iPhone, iPod, iPad, iTunes and iMac. And there is a real flood of businesses that don't have anything to do with computers that are tacking that little lower-case vowel on the front of their names.

Ironically, Apple itself is harking back to an earlier era with its iWork software. Here comes that "work" thing again.

I guess the really great naming strategies never die. They just go through a renewal and recycling period and emerge again, eventually, newly hip and full of dynamic meaning. Or seeming to.

But don't worry. Cabot has been Cabot for more than 44 years, and I don't think we're likely to turn out an InvestmentWorks newsletter, an Investment ZX publication or an iInvest advisory.

The name is Cabot. And we don't have a 00 prefix.

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My stock pick this week is Martin Marietta Materials (MLM), a major supplier of aggregates and other materials for construction projects. Here is the writeup of the stock from the February 23 issue of Cabot Top Ten Trader, the advisory that finds the market's strongest stocks early in their advances. Each stock selected for inclusion in Cabot Top Ten Trader gets a full analysis, including technical, fundamental and business analysis.

Why the Strength

Last week our Top Pick was Vulcan Materials, the largest producer of construction aggregates like crushed stone, gravel and sand in the U.S.-so far, it's been so strong that it hasn't traded in our buy range. This week might provide similar opportunity, however. Martin Marietta Materials is another big player in the same industry, with operations in 32 states, Canada and the Caribbean. As with Vulcan, Martin's business and profit margins are picking up thanks to improved demand from private businesses, states and municipalities; in the fourth quarter, the firm's aggregate volume rose 19%, while prices were up 7%, and synergies from its Texas Industries acquisition last August look to be large ($100 million annually by the end of 2016). Interestingly, even though Martin does good business in Texas, the company made it a point to say its energy-related aggregate sales are expected to remain strong. And looking at 2015, management expects shipments to rise 11% and prices to be up more than 5%, leading to another solid year. One last kicker: Martin approved a 20-million-share repurchase program that it expects to complete during the next three years, representing a whopping 30% of all shares outstanding! Throw in big earnings estimates for both this year and next (nearly 40% in each year), and the stock could do very well.

Technical Analysis

MLM has generally been a market performer for the past few years, with some good and bad stretches during that time. But now it looks like it's beginning a major advance-MLM topped out around 136 last June and declined into the mid-100s three times (October, December and most of January), wearing out all the weak hands. Now the stock has exploded to new highs on big volume on the heels of its great quarterly report. Dips are possible, but we're not expecting a major retreat anytime soon.

Sincerely,

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

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Paul Goodwin can be found on Google Plus.

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