Bubbles Are Good?by Timothy Lutts
May 21st, 2007
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Ive written before about perception as it applies to individual stocks, and
no doubt I will again. The fact that stocks move because peoples opinions of
them change, and not because of minute fundamental changes at the company, is
one of my favorite topics, and I think it needs repeating from time to time.
But today I want to discuss perception as it applies to bubbles. The takeoff
point for this discussion is a new book by Daniel Gross titled Pop! Why
Bubbles Are Good for the Economy. I havent read it, but reviews suggest that
the thesis is worth pondering for all of us.
Common wisdom, of course, tells us bubbles are bad for the economy. And
recent experience in the wake of the 2000 top of the Internet-centric stock
market bubble reinforces that conclusion among the vast majority of the
population.
But Gross argues differently. He doesnt deny the pain, in the aftermath of
the bubbles collapse, which accompanies bankruptcies, unemployment and
investment losses. But he argues that those are all offset - and more - by the
benefits accorded by the new infrastructure.
And he uses history to make his point, looking at the bubbles that
accompanied and supported the rise of the telegraph, the railway and the
Internet.
The telegraph bubble enabled rapid communication across the continent, and
thus enabled the creation of efficient financial markets. Increasing the speed
with which money could flow increased the speed at which business could grow.
The railroad bubble enabled rapid low-cost transport of goods and people
across the continent, and thus ushered in the age of consumerism and the age of
increased mobility.
And the Internet bubble? Without the thousands of miles of fiber-optic cable
laid in the buildout of the Internet, and the accompanying advances in the
technologies of data transmission and storage, we wouldnt have Yahoo!, Google,
YouTube, iTunes, Amazon, eBay, AOL, Monster, Skype, Netflix, Expedia or any of
the other Internet services that weve come to depend on.
Do those Internet offerings offset the pain and suffering that came in the
collapse of the bubble, or would you rather go back to life as it was in 1990?
I sure wouldnt, and I think most Americans would agree.
And now we come to the best part.
Gross hope, and I share it, is that the current enthusiasm for alternative
energy keeps on growing from here, inflating higher and higher, and becoming a
bubble big enough to draw in massive amounts of investment.
The result, ideally, is a new energy infrastructure that helps to reduce our
greenhouse gases and to free us from the complications (to put it mildly) of
imported oil.
It would be enormously disruptive, particularly for people in the oil and gas
industries. But the long-term benefits would be spectacular.
As much as I hope for it, however, I have serious doubts that a major bubble
in alternative energy will develop, and heres why.
In recent years Ive come to believe that the 2000 bubble was of the sort
that comes along only once in a lifetime. The logic behind this is that bubbles
of that magnitude can only form when memory of the previous bubble (and the
pain that followed it) fades from the collective memory of the populace.
Thus the 2000 bubble was only possible because most people who suffered in
the 1929 bubble were no longer involved in the economy, through either commerce
or investment.
The 1929 bubble was preceded by the Railway Mania of 1846 in Britain, and
that was preceded by the South Sea Bubble 1720, all far enough apart to support
the thesis that collective memory is key in preventing bubbles.
Today, of course, the memory of the Internet bubble is still quite fresh, and
so its easy for pundits to see (and fear) other bubbles. Theres the China
bubble, the housing bubble, the copper bubble and the solar energy bubble, to
name a few. The housing bubble in particular is one thats highly feared
because it would hit so close to (ahem) home.
Even the fact that Gross can sell a book about bubbles reflects the
prominence of the theme in the public consciousness. As a contrarian, I believe
trouble tends to come from where its least expected, so to me, all this
consciousness of bubbles means we wont have one.
Still I continue to enthuse about solar power stocks because the charts are
strong and the companies are growing revenues and earnings rapidly. Last Friday
many of these stocks had pulled back to their 50-day moving averages, offering
new investors in the sector a decent buying opportunity.
Some uranium stocks look good, too. Theres a carbon fiber company (an old
favorite of ours) whose product is being gobbled up by makers of wind-turbine
blades. And theres a company, public only four weeks, that generates
electricity from wave power. (Waves are more predictable than wind, and power
can be generated just offshore, very close to where people need power.)
Bottom line: while a bubble in alternative energy would be nice, you dont
need it to make money in the sector. The stocks of well-managed companies in
growth industries will continue to prosper, as they always have, and today we
find many of them in the alternative energy sector.
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Moving on, I want to thank all you readers who took the time to respond to my
request for feedback last week. It helps to know what youre thinking.
Heres what one reader wrote:
I like reading about why you like certain stocks as opposed to other stocks,
and always wonder if I use my paid subscriptions to newsletters correctly, as I
dont seem to ever get ahead. Often I lose heavily, as with Global Crossing and
other big names Im ashamed to mention. . . I continue to hold dogs like
SCON, DIVX, JDSU recommended some time ago by other newsletters while I also
hold things like VZ, DUK/SE, PFE, MSFT, DCX, APC and CSCO which I researched
and bought on my own. I sure wish you would cover that in one of your
newsletters. . . I realize that probably most of your readers are much more
sophisticated than I, but there may be dummies out there like me.
Okay, theres a lot to address there, but this reader is no dummy. It takes a
smart person to ask the right questions, and I present this letter here because
I think a lot of readers - especially newer ones - have the same questions.
So lets start at the top.
We all like to listen to experts and get advice on buying stocks. Buying is
easy, because its done with an aura of hope. Selling, on the other hand, is
hard, because it means admitting the dream is over. By refusing to sell, a
person keeps the dream alive, even though the profits dwindle, or worse, the
losses mount.
So when you recognize that your portfolio holds a dog, like Global Crossing
(GLBC), Superconductor Technology (SCON), or JDS Uniphase (JDSU), you should
sell! These three, in particular, are dogs because the companies generally lose
money. DIVX, contrarily, is a profitable company, but the chart says its a
dog, and one reason jumps out in a casual inspection: profit margins are
shrinking fast.
So whenever you buy a stock you should have an exit plan. Sure, youre
dreaming of a ten-fold gain, but the reality is likely to be different. When
you buy a stock, you should know what it will take to sell it.
Now, its nice if the expert who recommended the stock tells you when to
sell. And in all Cabots paid subscription newsletters, we do give specific
sell advice (with the exception of the Other Stocks of Interest section in
Cabot Market Letter). But youve got to take some responsibility. After all,
its your money.
Moving on to the good stocks in the readers portfolio, I see Verizon (VZ),
Duke Energy (DUK), Spectra Energy (SE) (spun off from Duke in January), Pfizer
(PFE), Microsoft (MSFT), DaimlerChrysler (DCX), Anadarko Petroleum (APC) and
Cisco (CSCO). And why are these good stocks? Because they tend to be in
long-term uptrends. Theyre not exactly market leaders; theyre rather large
(and therefore slow) to fill that role. But they are all extremely well managed
and many pay dividends.
But even good stocks shouldnt be held forever. Today were in a powerful
bull market and most stocks are acting well. If youre a newer investor,
perhaps youre pleasantly surprised with your ability to make money by
investing. But you should be aware that many times it is not this easy. You
should be aware that when this bull turns to bear, it will have the potential
to take away your profits as quickly as it awarded them. When that time comes,
the way to avoid losing money will be to sell.
This is just an advance notice, but I give it here because Ive seen what
happens to novice investors who fail to sell . . . and its not pretty. I
promise to write more on this in the future.
So now heres a specific piece of sell advice. It comes from the pen of Roy
Ward, editor of Cabot Benjamin Graham Value Letter.
One of our Wise Owl Model stocks, Exxon Mobil (XOM), reached its Minimum
Sell Price on Friday, May 4, 2007. We recommend that you SELL XOM now.
XOM, a giant international oil company, reached its Minimum Sell Price of
$80.94. XOM shares sell at 13.4 times forward EPS, which is slightly higher
than XOMs 10-year average P/E of 12.5. We believe oil prices will remain near
current levels or fall somewhat during the next 6 to 12 months causing XOM
earnings to decline by 5% to 10% during the next 12-month period. XOM was first
recommended in our September 2006 issue at $66.36 and has gained 22% in 8
months. We recommend that you SELL your XOM shares now.
Clear enough?
Now, you might say that since XOM has climbed from 81 to 84 since that sell
advice was given, the sell advice was wrong. Not true. The goal of investing is
to make money, not to buy at the bottom and sell at the top. And the method
used by Roy Ward is to buy when a quality stock is undervalued and to sell when
it exceeds its fair value. After eight months, XOM brought readers who followed
his advice a profit of 22%, and thats great. But at a price above 81, risk is
higher than his system likes, so he says sell and move on to another
undervalued stock.
I call that success.
Editors Note
Cabot Benjamin Graham Value Letter is your best source of investing advice if
youre looking for a low-risk long-term investment system you can follow with
no anxiety. It involves far less buying and selling than most systems, and
entails far less risk . . . as long as you follow the advice. Since inception
in 2002, the Classic Model has achieved a compound annual return of 26.2%
compared to 8.4% for the Dow. Since inception in 1995, the Wise Owl Model has
achieved a compound annual return of 16.5% compared to 7.4% for the Dow.
To get started with a no-risk trial subscription, simply click the link below.
http://www.cabotinvestors.com/ebgvhcwa05.html
Yours in pursuit of wisdom and wealth,
Timothy Lutts
Publisher
Cabot Wealth Advisory
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