The Iconoclast Investor

As I’ve written many times, when looking for the leaders of the next advance, you want new stocks–or at least newer names–with strong growth and, preferably, new and revolutionary products.  It’s also a good sign if this stock has recently reacted well to its third-quarter earnings report.

Volcano (VOLC) has all of these traits, and that’s why I’m watching it.  Here’s what I wrote about it in Cabot Top Ten Report on September 22:

“Volcano is looking to change the practice of ultrasound imaging.  Instead of using a wand outside the body, Volcano’s ultrasound catheters allow doctors to see blood vessels (and the plaque that blocks them) from the inside. These catheters don’t just take pictures; they can also distinguish one kind of plaque from another. Volcano sells consoles that display pressure and flow characteristics, then achieves additional revenues from the sale of single-use disposable catheters. At the end of 2007, the company had an installed base of 2,400 intravascular ultrasound (IVUS) consoles and over 800 functional measurement (FM) consoles. That’s not bad for a company founded in 2000. Volcano continues to develop and offer additional functionalities to its products, encouraging upgrades of existing equipment.  2007 was the company’s first profitable year, and earnings are still dodgy. But the small number of institutional owners is hanging tough, indicating some interesting potential. The company has been grabbing market share from Boston Scientific, and that’s expected to continue.”

On Wednesday night, the company reported another great quarter, as it indeed grabbed market share.  Revenues were up 40% to $44.1 million, thanks to a 78% jump in IVUS system sales and a 29% leap in IVUS disposable sales.  Earnings reached 6 cents a share, well above estimates, and management raised guidance going forward.

To me, the big-picture bullish statistic is that there are 6,000 catheterization labs (examination rooms in hospitals with diagnostic imaging equipment used in catheterization) in the U.S., Europe and Japan, and only 10% or so have IVUS systems. But that figure could jump to 90% within five years!  That spells huge, huge opportunity for Volcano.  The stock is still base-building, but if the market improves and VOLC can break above 19, it could be a big winner.

If you’re looking for more perspectives about stocks, the financial crisis and investing, some great ones can be found here. Enjoy!

I’m going to start today’s post with a warning: Over the next three months, be prepared to see some of the worst economic data you’ve ever seen.

Why do I say this?  It stems from the only economic indicators I regularly monitor, from the Economic Cycle Research Institute. The firm basically invented the concept of leading economic indicators–the guy who started the popular monthly leading indexes for the U.S. government left decades ago, founded this firm, and took the process to a whole new level.

The company has dozens of indexes, but the main one I monitor is the aptly named Weekly Leading Index.  It has a great track record of telling us what the economy will look like in two to three months.

Here’s the whopper: This morning, the weekly leading index’s growth rate stood at a minus 24.6%.  And what exactly does that mean?  Well, not only has the rate fallen off a cliff in recent weeks, it’s also the lowest reading … ever!  And this is no small data series–ECRI says that its data goes back to January 1949, nearly 60 full years of information.  That tells me that the next couple of months should see the sharpest slowdown/recession in decades.

Thus, this morning’s unemployment report (240,000 jobs lost, on top of a downwardly revised 284,000 jobs lost in September) is almost surely just the tip of the iceberg.  I would venture a guess that we’re all going to be seeing some truly scary, once-in-a-lifetime readings on jobs, industrial production, economic growth, you name it.

Actually, that process is already underway.  Just this week, General Motors reported monthly vehicle sales of less than 200,000 for the first time in years.  The figure was down 45% from just a year ago!  GM Sales Chief Market LaNeve said, “In my 27 years in the industry, I’ve never seen a month like this,” adding that, adjusted for population growth, October was likely the single worst month for the auto industry since World War II.

Another example came last night, when networking behemoth Cisco sharply cut its guidance.  For the current quarter, it anticipates revenues will decline 5% to 10% from the prior year, compared to earlier estimates of a 6% gain.  It might not sound dramatic, but the difference is from $10.4 billion (analyst’s former estimate) to around $9.1 billion (the new guidance).

If the Institute’s leading index is correct, and I believe it is, you should be ready for more such “worst in decades” readings in the weeks and months ahead.

Now I’m going to continue this piece with another word of advice: You shouldn’t read too much into the coming economic data.

Why did I write about the approaching maelstrom if you should simply ignore it?  Because I want you to be prepared for some hugely worse-than-expected readings, and (more important) for all the hoopla and headlines that will surely come along with them.

What’s key to remember is that the market has already discounted much of the bad news you’re going to read about.  That’s why the major indexes are down more than 35% this year, and why they crashed in September and October.  That doesn’t mean the market will shrug off all the bad news–the big drop on Thursday after Cisco’s earnings outlook (along with horrible retail sales reports) attests to that.

My point is that the market is reacting to what the economic landscape will look like in six months, not the economic readings of yesterday.  And from that point of view, I continue to think there’s a good chance that the market is beginning a bottom-building process.

Despite the declines seen this week, most indexes are still well above their lows of mid-October.  And, more important to me, the market is now 20 trading days removed from its major October 10 low, when a still-unbelievable 88% of all NYSE stocks hit one-year lows.

Stocks could (emphasize could) be starting a re-test process, where the major indexes again fall back to their October 10 levels.  Historically, bear market bottoms see these re-tests, and they usually occur anywhere from 25 to 40 trading days after the initial low (October 10, in today’s scenario).  So we’re right on schedule.

Seeing this process unfold also makes sense because, to get a sustainable rally (if not a whole new bull market), you need leadership, which is defined by companies with solid sales and earnings growth, and whose stocks are well traded and have built solid launching pads.  Right now, there are just a handful of potential leaders–at the start of a big rally, you’ll see a couple dozen, with more emerging soon after.

A re-test, then, is not something to fear, but has historically been a necessary and (eventually) bullish event that’s led to a sustainable upmove.  The latest successful bottom/rally/re-test process came earlier this year, in January and March.  While that didn’t lead to a new bull market, it did lead to a two and a half month rise, led by commodity stocks, providing some nice profits.

Thus, on the indexes, here’s what to watch for: See whether the Dow can hold above 8,000 to 8,300 or so, and if the S&P 500 can hold the 850 area.  If they decisively break below those levels … well, then, just remain defensive, and be glad you’re holding on to your capital.

However, if the indexes do re-test those levels sometime in the next couple of weeks, sit up in your chair–the market may have laid the groundwork for a few good months ahead … despite what the economic indicators may say.

Last week I wrote about the U.S. national debt and I received many comments from our readers, some of which are found below. If you have something to say about this or any other topic, please leave us a comment.

“The good news regarding the debt: If these bailouts work, we’ll get that money back in a few years. Much more troublesome is the debt we had already accrued through 2007 …

“A reasonable approach is not to worry about paying back the deficit. That seems impossible. What does need to be done is balance the budget, which will be painful but is possible over a few years’ time. If we do that, then the burden of the interest on the debt will lessen over time.

“But does the nation have the willpower to do even that? I doubt it.”

J.

—

“I believe your numbers that we owe are terribly incorrect if you consider that those people who don’t pay any income taxes now, the additional ones that will not pay taxes under Obama’s new plans and how do we account for those who can’t pay their mortgages? Seems to me the numbers will increase significantly per middle class American. How frustrating is that?”

L.P.

—

“Someone important said long ago, (I don’t remember who), that democracy works fine until the politicians discover that if they pass out entitlements, and gifts to the public, they can get re-elected. When they fully comprehend that principal, democracy fails.

“Our politicians have learned this well.

“I fear that your wish for fiscal responsibility is a far off pipe dream.”

G.M.

—

“Keep pounding on the debt issue. It is the most serious problem we have had since the Great D. In all likelihood, we’ll print more money, which will lead to serious inflation. God forbid China redeem its Treasuries, although they are talking about it. And, they’re talking to the Russians about more trade agreements, particularly on energy.”

G.S.

—

“The national debt? It’s disgusting and we’re just now seeing how dangerous. I blame both houses of Congress since they initiate the bills that become law. The president can only push, but that’s important as well. I only hope that as the nation works through this we do not return to our old reckless credit ways. But I fear greed is the larger driving force.”

Best Regards,
W.W.

My investing idea for today goes back to the Simplified Cabot Market Timer I wrote about a few days ago.  It’s also a simple idea, but it should do well for you as the market deals with a stagnating economy and takes the measure of the new administration.

This idea is this: When you get a buy signal from the Market Timer, take a position in the iShares S&P 500 Index exchange traded fund.  You can pick either the S&P 500 Index (SVV) or the S&P 500 Growth (SVW), if you’re feeling a little more aggressive.  Either one will gain you broad exposure to large-cap stocks that represent every sector in the U.S. market.

If the Simplified Cabot Market Timer turns negative on you, all you need to do is sell the iShares ETF and move back into cash.

While this investment idea doesn’t have the giant upside potential of individual stocks, I can virtually guarantee you that it will beat the performance of the broad market, which is all the managers of most of your 401(k)s and IRAs are trying to do anyway.

I think of myself as a very reasonable man, and I don’t resort to the rant mode often.  It requires lots of energy and sheds very little light.  But with a watershed election just behind us, I’ve been thinking more than usual about the national policies of the United States, and there’s one huge issue that just drives me nuts.

The issue is energy, and our national energy policy … or lack of one.  And that’s a crime.

After all, it’s not as if the high cost and limited supply of oil just sneaked up on us.  Is our sense of history so stunted that the Oil Crisis of the 1970s is too ancient to be considered relevant?

We learned during the Oil Embargo, when OPEC was first flexing its muscles, that being dependent on foreign oil was painful, embarrassing and potentially disastrous.  Foreign countries used the biggest hammer they had to put several dents in our collective head, with economic consequences that lasted for years.

Accordingly, given that protecting our citizens from threats posed by foreign powers is the prime constitutional duty handed to those who occupy our highest offices, it became the primary duty of the federal government to take that hammer away.  It’s laughably obvious.

It was so obvious, in fact, that after a few years of cheesy miniature cars and a small burst of solar energy buildout, the entire alternative energy/energy conservation movement was allowed to fall off the national agenda.

The movement continued underground, but the federal government, the entity with the responsibility to protect our nation (and sufficient power to actually get the job done) just dropped the ball.

*No ambitious standards for automobile fleet fuel efficiency.
*No massive support for wind or solar or tidal or geothermal or even nuclear, for that matter.
*No game-changing commitment to railroads or public transportation.

And remember, this is not a matter of environmental or social policy, this is about the economic foundation of our economy and its vulnerability to foreign threats.

This ball has been dropped so many times by so many people that I can’t even figure out who to blame!  The administrations (of both parties) for not leading forcefully?  The legislative branch for caving in to lobbyists of auto and oil companies?  Regulatory agencies for slacking off on enforcing even the wimpy standards we have on the books?  Private citizens for acting like drunken pigs in a corn bin?

The private sector has been making progress, but it’s been irregular and unsupported.  It’s not really fair to expect giant oil companies to demonstrate a huge commitment to deploying technologies that will interfere with the sales of existing products.  The scientists at Big Oil and Big Auto have made some awesome discoveries, but the real breakthroughs (like First Solar’s reduced-silicon chips) have come from tiny firms.

What I think should have happened (and what I would like to see happen in the future) is for the U.S. government to make the kind of investment in energy independence that it has made in the Star Wars missile shield.  I think a case that can be made that freeing the United States from the reliance on oil from hostile nations stands a better chance of protecting us from our enemies than does an unreliable missile shield.

I’m not a conspiracy buff.  I have no opinion on the notion that the U.S. is fighting in Iraq and Afghanistan to protect our oil.  Similarly, I have no real evidence that any car company has ever knowingly suppressed any technology that would have revolutionized the automobile, nor any oil company quashed a miraculous fuel saver.  All of these things may have happened.

The one thing I’m sure hasn’t happened is a burst of leadership and vision that can wean my country from its oil supply.  It’s matter of national security, and I hope to see it in my lifetime.

The U.S. stock market has been showing a few signs of life recently, which is good.  I hope the period of catastrophic declines we’ve been going through hasn’t hurt your portfolio too badly (although I suspect the pain has been pretty widespread).

I have been telling the subscribers to the investment advisory I edit, Cabot China & Emerging Markets Report, to be more than 80% in cash for a while now.  In fact, I sold the last stock from the Report’s portfolio on October 16.  Before that, the Report had been cutting back steadily since July.

It’s a message you probably read in these pages, too.  Every editor of Cabot’s growth newsletters has had the same advice.  I hope you took our advice to heart, because it is the only rational way to handle this kind of negative market.

Markets don’t stay down forever, and this historic selloff has created a whole raft of bargain stocks.  There’s just one problem.

How do you know when to get back into the market?

Here’s an easy way to tell, one that’s based on one of Cabot’s powerful set of market timing indicators, the Cabot Tides.

This method will help you figure out when the market’s recovery is robust enough to make it worth your while to start investing again.  It won’t guarantee success for either the market or your individual investments, but it will put the odds in your favor and give you the confidence you need to overcome the aftereffects of this bearish period.

Step One: Get an online chart of the S&P 500 Index.  This will be available on most sites that feature finance sections.  Yahoo! Finance: use symbol ^GSPC or StockCharts: use symbol $SPX will do fine, although just about any chart facility will do.

Step Two: Set the chart to show two moving averages, the 25-day and the 50-day.  Yahoo! uses pull-down menus, while StockCharts keeps its controls below the chart.

To get a new buy signal, you need two things:

First, the Index itself must rise above the lower of the two moving averages.  (As I write this, the Index is pulling back to just below the 25-day moving average).

Second, the line for the moving average must be moving up.  (Today, the 25-day average is still trending resolutely down.)

Both of these conditions must be met to produce a new buy signal.  When you get a buy signal, you can start putting your money back to work, although you will still need to follow the other rules for growth investing, such as buying on pullbacks, cutting your losses short, averaging up in your winners and stepping into the market gradually.

This indicator–I’ll call it the Simplified Cabot Market Timer–isn’t as finely tuned as the timing indicators refined by the Cabot Market Letter during its 38 years of publication, but it will serve you well if you follow its advice.

Our financial system lies in shambles, and the dominoes continue to fall, bringing down companies and stocks in one sector after another.  Consumer confidence is absolutely terrible.  Friends who previously asked about my market opinion simply as a common courtesy now ask because they’re genuinely worried about their own retirement funds … and about the future of America.

And what do I tell them?

“This too shall pass.”

I tell them America is a country with great and diverse assets, and that while the stock market may have lost more than 40% of its nominal value from peak to trough, the actual loss of real value in our net worth is far smaller.  Plus, many companies now have far better balance sheets!

Of course, a lot of people don’t think about balance sheets, they think about revenues and earnings.  That was one factor in building the recent bubble.  In the future, I believe a little more attention to the balance sheet will be a good thing.

I also believe that the big bear market we’re likely leaving behind has provided a perfect opportunity for investors to clean house, to jettison the stocks of tired old companies and to invest in the leaders of the next bull market when it arrives.

Four sectors in particular are on my mind.

Four Sectors for the Future

The first is alternative energy, for all the obvious reasons.  Both parties have been making supportive noises and the Democrats in particular can be counted on to advance numerous initiatives in solar power, wind energy, electric cars and more.

And because the industry is still very young and small, relative to the oil industry, the growth potential is enormous.

Cabot did well investing in the solar power industry back in 2007 and we’ve been sitting on the sidelines watching the stocks correct this year, even as the companies continue to make good progress.  In an upcoming issue of Cabot Wealth Advisory, I’ll give you a complete rundown on the solar stocks.

But the stocks don’t look good yet.  The selling pressures that followed the gains of 2007 are still holding the stocks down, and there’s no telling how long this will go on.  Bottom line: you shouldn’t invest in these stocks until investors start pushing them up again.

The second sector I’m looking at is the government … for the simple reason that it’s one of the few sectors that are growing today.  Furthermore, it looks as though the trend toward increasing government involvement in our lives may continue, bringing us a system somewhat closer to those in France and Germany.  Some people applaud the change, some don’t.  I say acknowledge it so you can invest accordingly.

As we move inexorably toward universal coverage of health care, for example, the government’s role in that industry will increase, and there will be winners and losers among the public companies that supply goods and services in the industry.

Which brings me to my third sector, health care.  Health care is already huge; it accounts for nearly 20% of our national economy.  So there’s no way it can boom like the alternative energy industry.  On the other hand, the aging of the big baby boom generation means naturally increased demand for services.  Furthermore, there are some hot spots in the industry where money is flowing fast and where fast-growing companies offer tempting investment prospects.

Genetics is one.  We’ve written about several genetic technology companies in recent months, both here and in Cabot Top Ten Report.

Cancer is another.  Any company that can cure–or even better, prevent–cancer will see its shares shoot to the moon.

Infection control is huge, as well.  It’s a simple problem, yet the most widespread of all.  And the new insurance rules that deny payment to hospitals for their mistakes (like infections contracted during surgery) are excellent incentives for progress here.

The fourth sector is simply this … securities that pay good dividends.  Dividends, you see, have been neglected in recent years.  Investors haven’t craved them, and companies that could have paid them haven’t.  Apple (AAPL), for example, has $25 billion in cash and has not yet chosen to institute a regular dividend.

But the recent bear market means that more companies will be thinking about increasing their dividends to make their stocks more attractive, and that those that don’t, like Apple, might consider instituting them.

It also means, of course, that investors like you are hungrier than ever for safe investments that can provide regular income.  And the best place to get advice on dividend-paying investments is Income Digest, our monthly newsletter from the editors of Dick Davis Digest.

A few months ago, I wrote about the movie “I.O.U.S.A.” and the United States’ enormous national debt. That was before the government rescued AIG for $85 billion and before the $700 billion government bailout plan passed Congress, part of which is being used to inject $250 billion into banks in exchange for equity.

After seeing “I.O.U.S.A.,” which focuses on the national and personal debt in the U.S., I was worried, to say the least. When I wrote about the U.S. debt after seeing the movie on August 21, it was at a whopping $9,618,734,657,724.09, according to the Treasury Department, which has a nifty little Debt to the Penny feature on its Web site.

The filmmakers estimated that the national debt would reach the $10 trillion mark by January 2009. Unfortunately, no crystal ball could predict that in the next two months the financial landscape of the U.S. would be drastically altered.

The national debt has reached $10,523,955,355,856.66 as of October 24, an increase of 9% in about two months. These numbers are nearly too large for the mind to comprehend. To break it down, it means that if every American had to re-pay this debt, each person would owe $35,079.85. And if the debt were just to be re-paid by Americans over age 18, each one would owe $46,773.13.

I don’t know about you, but I certainly don’t want to be on the hook for $46,773.13, or even $35,079.85, to the federal government. I still have mixed feelings about the bailout, as it didn’t stem investors’ panic in the short term. But I’ll try to have a little patience as we wait to see what the future brings. The housing bubble and credit crisis weren’t formed overnight and I don’t expect them to go away that quickly either.

But I do believe we need to demand more fiscal responsibility from our government, something with which it has had a difficult time. Even before the economic crisis, the U.S. government was piling up debt like it was Monopoly money. And now, the buck will get passed to whomever is elected on November 4.

To the next president, I would say this: Get the financial system back on track by setting an example for the American people. Instead of spending more than you have, live within your means, save money for a rainy day and invest in the future.

Nearly every presidential candidate says he is going to reduce spending and balance the budget, and some have done better than others once elected, but now, perhaps more than ever, we need the government to get spending under control. The country has hit a critical mass of debt.

Obviously, we can’t just shut down the government to get the debt under control or cut programs that are vital to the country’s operations, but someday these bills are going to come due. Someday it will be time to pay the piper.

Here’s another question I received recently. Again, feel free send us any questions you have and keep checking back to see them get answered.

Question: I’ve waited patiently for a new bull market.  Once it arrives, what’s the best way to take advantage of it?  Should I become fully invested immediately?  Buy leveraged ETFs?  A mixture of both?

Answer: There is no one perfect way to play the market … but the key is to have a game plan going in.  For my part, I’m a big fan of taking things slow. I know most investors, especially if they’ve waited out much of the bear market on the sideline (as have my subscribers), are eager to get back in, and make sure they don’t “miss the boat.”

But I’ve got news for you:  Any new bull market is going to last months and years, not two or three weeks.  And my studies of the past have shown that many of the best winners don’t come off the launching pad until a few weeks after the bottom.  That is certain to be the case this time around, as the number of good-looking growth stocks capable of leading this market higher is currently tiny–I would say fewer than five.

Thus, when buy signals come, it’s best to put some money to work, and then observe.  If your stocks don’t go up, don’t buy any more.  But if the market acts well, and your new purchases get off to good starts, you can look to average up on those purchases, or add another stock or two to your portfolio.  And then go from there.

As for what to buy, that’s really a matter of personal preference.  I like to find individual stocks that can double, triple or more at the start of a new bull market.  And I run a fairly concentrated portfolio–usually no more than eight stocks.  But there’s nothing wrong with using index or sector ETFs, but the same principles apply; cut all losses short, let winners run, and only buy more if your portfolio is advancing.