How to Know When a Bull Market Starts?

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The Law of Unintended Consequences

How to Know When a Bull Market Starts?

A Strong Stock in a Weak Market

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We have fun with laws all the time. Think of the bumper sticker that says: "Gravity, It's Not Just a Good Idea, It's the Law." Or how about the law that says that your supermarket line is the one that will jam up with a price check or a little old lady searching in her purse for exact change? Or even the one that says that toast that falls off the table will fall buttered-side down (one of the many variants of Murphy's Law)?

There is, however, one law that's been a favorite of mine ever since I ran into it in a college history class. It's The Law of Unintended Consequences.

The classic example of the LUC is the Treaty of Versailles that ended the First World War. The victorious allies were somewhat peeved with Germany, and celebrated by imposing harsh reparations and economic restrictions to punish it. (Just a bit of trivia: one of the provisions of the Treaty was that Bayer, the German pharmaceutical giant, was forced to give up two patented pain relievers. The first was being sold under the trademark Aspirin. The second was trademarked Heroin. But more about that later.)

The popular LUC theory is that the huge burden of monetary reparations and strict industrial limitations placed on Germany created the economic chaos, hyperinflation and desperate national mood that allowed the Nazis to come to power and start WWII. (Some historians disagree about this, but historians will disagree about just about anything, so they don't get a vote.)

True or not, it's the perfect story to illustrate how ignorance, stupidity, short sightedness, malice and the vagaries of chance can turn well-meaning attempts at rule-making into a source of negative outcomes.

Another classic example of bad results from good intentions is America's 13-year experiment with outlawing the sale of alcohol, known variously as the 18th Amendment to the Constitution, The Volstead Act or just plain old Prohibition.

It's universally accepted now that Prohibition was a dismal failure, succeeding only in allowing organized crime to grow into a profitable colossus, encouraging the production of untold gallons of questionable (and sometimes dangerous) brews and liquors, and turning millions of Americans who just wanted a little drink into criminals.

I'm also fond of the LUC examples of how boxing gloves and football helmets actually contribute to concussions and repeated head trauma, but that's a story for another time.

My favorite current example of the Law of Unintended Consequences is the Fiscal Cliff. It's not that the Cliff itself is an unintended consequence; I think the lawmakers who made the interim budget deal that created this artificial deadline probably had a pretty good idea that it would come down to the 11th hour before a deal got done.

Rather, the LUC is waiting patiently on the sidelines, ready to evaluate the tax/spending deal that eventually gets done and then gets busy producing effects that nobody expected, wanted or imagined.

Many analysts, commentators and even politicians seem to think that they know exactly what should be done, and how their actions will affect the U.S. and global economies. But they're wrong. The Law of Unintended Consequences says so. And it's the Law.

The Law of Unintended Consequences is a serious business, but not a solemn one. It can produce misery, and dire results, but it also yields the kind of ironic outcomes that make great stories.

To get back to my bit of Bayer trivia, I like to point out that there have been two attempts to produce a non-addictive form of opium. Everyone wants the pain relief that opium brings, but addiction is a high price to pay. So a German pharmacist, convinced that it was the impurities in opium that made it bad, refined it and named the resulting compound for the Greek god of dreams, Morpheus. Thus was morphine born.

Working on the same principle of purification, Bayer further refined morphine and marketed the resulting compound as an over-the-counter pain reliever beginning in 1895, taking its name from the German word heroisch , which means "heroic." It's not a name most people would apply to heroin these days, but that's the way the Law of Unintended Consequences works.

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I don't often tell anyone what to do, but I'm telling you now. You need to pay attention to what I say at the end of this little section. It's as important as anything I've ever written, at least for those of you who think you might ever want to invest in growth stocks again.

You may have noticed that the U.S. stock markets got a nice boost on the morning of December 3. It didn't last long, of course, but when markets are unsettled, any rally makes it feel like the sun has come out from behind the clouds.

What interested me about this rally was that the good news the fueled it was about a report that indicated a return to growth in Chinese factories. The Purchasing Manager's Index (PMI) is a closely watched measure of how much buying is being done in China's manufacturing sector, and any number over 50 is interpreted to reflect growth. So the 50.5 PMI number was taken to mean that China's economy is returning to growth. That's good news, even if it is pretty slow.

As a dedicated China watcher, the PMI report didn't have me exactly dancing on the tables at the local pub, but it was better than further contraction.

If my analysis of the global macroeconomic situation is correct, solely relying on a resolution to the Fiscal Cliff standoff isn't enough to produce a genuine, durable bull market.

To get the bull that we're all hoping for, we will have to wait for a convincing, durable solution to the crisis in Europe that will:

1) either keep Greece in the Eurozone or kick it out for good and 

2) re-liquify its banking sector and 

3) decide how much refinancing will be made available for Greek's debt and how it will be repaid, and

4) make similar arrangements for dealing with the potential problems in Italy and Spain.

That's a tall order, one that will entail more fiscal and social pain than European countries are willing to accept right now. Just as with the Fiscal Cliff, the challenge is so daunting that only the prospect of genuinely catastrophic consequences will force the parties to accept the pain.

But the point of all this maundering is this: The most important thing you can know as a growth investor is when a bull market has begun . During bear markets, or when markets can't really make up their minds which way to jump-which has been the case for the last couple of years-the best you can usually hope for is to break even, or maybe snag an occasional winner.

Bull markets are different. Bull markets make lots of stocks look like they've gotten off the stairs and are taking the escalator. And the best growth stocks will look like they've finally gotten on the elevator. And a brilliant few will look like they've hitched a ride on a moon rocket. Bull markets make you feel smart. They make you glad to look at your brokerage account. Life is good when the bulls are in charge.

And the best thing about Cabot's growth investing letters- Cabot Market Letter, Cabot Top Ten Trader and Cabot China & Emerging Markets Report -is that their market timing indicators give definite, unambiguous buy signals when markets turn bullish.

The old investing adage that says, "If you think it's a bottom, you're too early; if you know it's a bottom, you're too late," has a seed of truth in it. But the truth is that most people wait entirely too long to get back into the markets after a long correction or a period of up-and-down trading.

I hate to seem too commercial, but subscribing to a Cabot growth letter can give you the confidence to put your money to work weeks or months before you are emotionally ready to accept that markets have turned around. Which, of course, is usually the best time to do so.

Our stock picking is very good. But our ability to make definite calls on what the markets are doing right now is the best thing we do.

If you have any growth investor blood in your veins, a Cabot growth letter can be the most valuable tool in your investing toolbox.

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My stock pick today is a great example of a strong stock that has been doing well despite a weak market. The company is Nam Tai Electronics ( NTE ) , a Chinese manufacturer of LCD display panels and modules for consumer and telecom markets. The company has been in business since 1975, and had a reputation as a well-run, profitable business, but not one that was going to do anything spectacular.

Then Apple entered the picture.

Suddenly, Nam Tai, which had been more of a commodity producer, began booking huge sales of its high-margin LCD modules. The company's Q3 results revealed revenue growth near 200% and earnings growth of 5,200%, up from a penny in Q3 2011 to 53 cents.

Apple never reveals the names of its suppliers, so much of investors' enthusiasm for NTE is conjectural. But it's a pretty well nailed-down conjecture.

Nam Tai is in the process of building new manufacturing space, and management says that the company will shed some of its low-margin business to concentrate on module making. Estimates for 2013 are positively rosy.

NTE has spent years as an up-and-down dividend-paying stock that hadn't traded above 10 since August 2008. But the stock began to gain momentum in August, blowing past 10 on big volume, then spent two months trading in a range between 10 and 12 while investors waited to see what surprises third-quarter earnings would bring. And when that news was good, the stock popped to 15 in a day and has been digesting that gain and moving to new highs ever since.

NTE is hot right now, and that presents challenges for how to buy and how to handle the stock. One strategy is to buy in on one of the stock's downticks, like the one today that took three-quarters of a point off. The other is to take a small position and then add to it if NTE can push past 16 on good volume. In either case, the stock's 4.0% forward annual dividend yield will make it a little easier to ride out the daily waves.

Sincerely,

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



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: NTE

Cabot Heritage Corporation

Cabot Heritage Corporation

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