The next rally won't be like the last one--here's how to make sure you find the next leaders

06/11/2010 8:30 am EST


Jim Jubak

Founder and Editor,

If the bull market that ended in 2000 the bear market that began in 2000, the bull market that began in 2003, the bear market that began in 2007, and the possible bull market that began in 2009 and that may or may not have ended in 2010 teach investors anything, it’s Don’t get stuck in a rut.

It’s incredibly hard not to get trapped in the rut of the familiar as an investor. We all tend to invest in what we know, to try to stay in our comfort zone by putting our money into the comfortable.

But over the last decade and more, investing in the same stocks from one bull market cycle to the next hasn’t been the way to score the biggest returns.

During this period not only has the stock market been extraordinarily volatile but the leadership in each bull market rally has been radically different from the leadership in the previous rally.

Keep that in mind as you get ready for the next bull market—whether it’s just a cyclical bull rally inside a longer secular bear (as I suspect) or a long secular bull like we enjoyed in the 1980s and 1990s (I hope but I doubt.) For more on why I think we’re in a long secular bear market see my post from February 2010

And keep it in mind as you revise your watch list of stocks that you’d like to buy in the next bull. (I started a big overhaul of Jim’s Watch List with my June 8 post )

Today’s topic is how to bust your investment thinking out of any ruts. And I’ll be adding some of those rut busters to my watch list with this post.  

A different group of stocks has been the star in each bull market cycle recently.

In the bull market that ended in 2000 technology stocks led the way. The Technology Select Sector SPDR (XLK) was up 65% in 1999, for example.

But in the next bull market technology stocks stunk and you would have done much better with energy shares. In 2005, for example, right in the middle of the bull cycle, the Technology SPDR returned 0.18% for the year. That same year the Energy Select Sector SPDR (XLE) returned 40%.

In 2009 you would have done fine with the Financial Select SPDR with an 18% return for the year or the Energy Select SPDR with a 22% return but the pendulum had swung back to Technology Select SPDR with a 51% return and to a new sector, the Materials Select Sector SPDR (XLB) with a 48% return. (What’s in that sector? Stocks like E.I. du Pont (DD), Monsanto (MON), Freeport McMoRan Copper & Gold (FCX), and Nucor (NUE).)

And for the next bull?

I gave you my top down, macro view of where you’ll want to put your money in my post . Top down my recommendation would be to overweight emerging market stocks, commodity stocks, and financial stocks.

But this kind of top down thinking still leaves you vulnerable to getting caught in a rut when it comes to picking individual stocks in those sectors.

Do you want to own BHP Billiton (BHP) in the next rally because it’s familiar and because it returned 82% in 2009 when commodity stocks, a top down recommendation for the next rally, did so well? What about the proposal from the Australian government for a 40% tax on mining products that has roiled the industry there? Are you just picking BHP Billiton because it’s a name you know?

Among the financials should you buy Goldman Sachs (GS) because it’s familiar and because it returned 102% in 2009? Even though it looks like the company could be charged with obstruction of justice by the committee investigating the global financial crisis?

Among emerging market stocks should your pick be Baidu (BIDU) because it’s familiar and because it returned 215% in 2009? Are you really betting that another dominant global competitor (as if there are other search engine companies like Google (GOOG)) is going to pull out of China’s market in the next 12 months?

Maybe you do want to add these familiar past winners to your watch list for the next bull rally—but only, I’d advise, after you’ve scoured your discomfort zone to find unfamiliar stocks that may be better horses to ride for the next cycle.

So how do you explore you’ve discomfort zone for potential watch list stocks?

I’ve got a technique I use that I call reading in the margins.

Most newspaper, magazine, and Internet stories about sectors or trends or market moves begin with companies and stocks that you know. It makes perfect sense: Writers and editor know that a larger percentage of their audience is interested in news on ExxonMobil (XOM), for example, than on Occidental Petroleum (OXY) than on Swift Energy (SFY). If the story is on the financial industry, the lead example is likely to be Goldman Sachs, Citigroup (C),or  JPMorgan Chase (JPM) and not Middleburg Financial (MBRG) or Bank of Marin Bancorp (BMRC).

But go to the end and you’ll see throw-in examples that flush out the story. That’s where I found Aixtron (AIXG), a maker of equipment to manufacture LEDs that I recently added to Jim’s Watch List. (See my post ) There at the end of a Financial Times wrap up on the day’s stock market action in Europe was this half sentence mention: among the biggest losers on the Frankfurt exchange was Aixtron, the leading manufacturer of LED equipment. That was it. But that’s all the lead you need. From there it’s just a research job to find out that Aixtron isn’t just a leading manufacturer of LED equipment but the dominant maker of the machines that deposit the thin films that make up an LED. (The daily market summaries on the last page of the Financial Times are one of my favorite “discomfort zone” hunting grounds.)

Reading an exhaustive story or package from an angle that’s 90 degrees out of alignment with the editorial mission of the writer is even more productive. For example, recently The Economist did a huge cover package (in the April 17-23, 2010 issue) titled “The new masters of management: A 14-pag special report on innovation in emerging markets.”

I’m not especially interested in management or in the trends that make one management style hot today and not tomorrow. But a story like this could throw up lots and lots of one or two sentence references equivalent to the Financial Times mention of Aixtron.

And it does—but none that are really investible right now.

Bharat Forge. This Indian company has recently teamed up with KPIT Cummins to produce an inexpensive hybrid conversion kit. Unfortunately, the stock trades only in Mumbai. Not every company mentioned leads to an investable idea.

Tata Consultancy Services recently bought Citigroup Global Services, the outsourcing arm of Citigroup (C). (And who says the global financial crisis didn’t produce any winners.) This one too trades only in Mumbai.

Infosys Technologies (INFY), on the other hand, trades on NASDAQ. The Indian information services company grew sales by 40% in 2009. Unfortunately, it might be too expensive for my watch list. The stock traded at $57.38 on June 8 and the 52-week high was only $63.73. The recent sell off hasn’t done much damage to this emerging market stock.

But my hope is always that even if a particular article, post, or report isn’t especially rich in investment ideas itself, it will provide leads that are. So The Economist package mentions a study of new global leaders from emerging markets by the Boston Consulting Group. And lo and behold the 2009 study “The 2009 BCG New Global Challengers” is available for free online at (For my own take on a similar group see my post )

At first the study seems as frustrating as the package in The Economist. Brazil’s Votorantim Group is one of the world’s top five zinc producers but it doesn’t trade on any U.S. market. India’s up and coming United Spirits, of course, only trades in Mumbai. Marcopolo, a leading global producer of buses and bus components trades only in Sao Paulo.

But gradually things start to look up. Johnson Electric, a leader in the manufacture of small electric motors, trades good volumes in Hong Kong and on the Pink Sheet market in the United States. Mexichem, which is the No. 1 or No. 2 producer of plastic pipes in Latin America, also trades on the Pink Sheets.

And finally—investible ideas worth a spot on my watch list.

Gerdau (GGB) is the dominant and low-cost steel producer in Brazil. Its major markets are Brazil and the United States and the company shows a return on invested capital of 22% over the last decade, according to Morningstar. It trades as an ADR on the New York Stock Exchange.

America Movil (AMX) has used the cash flow from its 70% share of the Mexican wireless market to expand into the rest of Latin America. Brazil now provides 20% of the company’s revenue.

Li & Fung (LFUGY.PK) is one of the biggest creators of customized supply chains in China for companies that include Wal-Mart. The company is also the largest operator of convenience stores in China.

I’m going to add these three stocks to Jim’s Watch List today.

And tomorrow I’ll keep looking for more stocks that fall outside my comfort zone and that will keep my portfolio out of a rut in preparation for the next market.

Full disclosure: I own shares of Bank of Marin Bancorp and Middleburg Financial in my personal portfolio.
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