After underperforming for the most part of the past 6 months, Cirrus Logic ($CRUS), which is one of Apple’s suppliers, gapped down again this morning after giving a disappointing guidance. In a about a year, $CRUS went from $19 to $45 back to $19. This is a typical momentum story in a condensed period of time. What are some of the lessons its story reminded of:
1) Once a stock breaks out to new 52-week high from a proper base and on fresh earnings-related catalyst, you don’t know how far the re-pricing could get and for how long the new trend could continue. One of Stanley Druckenmiller’s famous quotes in ‘The New Market Wizards’ book goes something like this:
I never use valuation to time the market. I use liquidity considerations and technical analysis for timing. Valuation only tells me how far the market can go once a catalyst enters the picture to change the market direction.
I wholeheartedly agree with the first part, not so much with the second. I don’t think anyone knows in advance how far a stock could go after it breaks out and any projections are just guesses.
2) Price trends often start and end before earnings trends. When $CRUS destroyed the earnings estimates in November of last year, many people were shocked to see the market reaction – a gap down from $41 to $37. At the time, it was perceived as a buying opportunity by many, citing the spectacular earnings growth. It has been all downhill ever since. The lower the stock went, the more attractive it looked to many, only to be disappointed as surprises often follow the direction of the established trend, until in the end – knowing when that elusive end could be is extremely useful. Poor reaction to what is perceived to be a good earnings report is usually one of the first signs that the price trend is over and since the price is the only thing that pays us, it is the main trend we should pay attention to.
3) Stay away from stocks with low relative strength, especially if they have been recent momentum leaders. In the majority of cases, you will be served better if you stay away from stocks making new 3-month lows (even worse – new 52-week lows) during bull markets. Most of stocks are there for a reason. No matter how appealing the seem from whatever perspective you chose to look at them, you will do yourself a favor not to touch them and go fish somewhere else.