Why Stocks Go Lower - Cramer's Mad Money (3/21/17)

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Includes: ADBE, CLX, CRM, DATA, GLD, MSFT, WBA
by: SA Editor Mohit Manghnani
Summary

Watch out for buying opportunities in stocks that go down on guilt by association.

Recognize the key metrics that impact your portfolio.

Don't have more than 10 stocks in a portfolio.

Stocks discussed on the in-depth session of Jim Cramer's Mad Money TV Program, Tuesday, March 21.

Cramer dedicated the show to educating investors. He said market sell-offs can be daunting, as many a time there is no tangible reason for a sell-off. Investors need to remain calm and make the declines work for them rather than being bogged down by them. Things were simpler when Cramer started trading, he said. Stocks used to trade based on fundamentals and the sector they traded in. Then, S&P 500 futures came into play and the market started trading as a whole.

"The biggest stock mover out there is the power of the S&P 500 futures over all individual stocks, including ones that aren't in the index," Cramer said. Futures can crush stocks irrespective of the health of the company and the underlying fundamentals. "Much of the damage from the crash of 1987, where the Dow fell 508 points in one day, and then plunged again the next day before an anemic recovery, was almost entirely due to the relationship between the futures and the common stocks in the S&P 500," he added.

Stocks became undervalued, executives started buying back stock aggressively and takeovers started taking place. That's when Cramer realized stocks were no longer accurate forecasters of the future. "We're never going back to those halcyon days where all that really mattered to a stock's price was the sector's interaction with the business cycle, along with the worth of the company and the executives who drove it," he stated.

Another reason for stocks to go lower are private equity and hedge funds. Since these funds need to make money for their shareholders, they often sell in a hurry to make profit, causing the supply of stock to rise, and thereby crushing the price without a change in fundamentals.

Case in point is Walgreens Boots Alliance (NASDAQ:WBA), which reported good earnings, and the stock was trading at $81. It was normal for shareholders to buy the stock on the notion that the company is doing well. However, at that time, two hedge funds used that news to sell millions of shares at a discount to book profits and raise cash. This led to the stock price falling sharply.

If the funds cannot sell privately, they do it in the open market, which crashes the stock price immediately. Such declines can become buying positive opportunities for investors, but one must be careful to detect a bottom before buying in order to avoid huge losses. That's why Cramer asks investors to book profits on stocks that get a takeover bid, as the risks become greater than the rewards.

Guilt by association

Cramer continued talking about the reasons why stocks go down despite having strong fundamentals. Another key reason for such fall is guilt by association. This means when one stock goes down, it takes the entire sector down with it.

In February 2016, Tableau Software (NYSE:DATA) and LinkedIn (LNKD) reported poor results with a slashed outlook. As a result, both the stocks were crushed in half and took down the sector with them, even when other companies like Salesforce (NYSE:CRM) and Adobe (NASDAQ:ADBE) had strong businesses. There were no changes in the earnings outlook of these companies, and yet, their stocks had to suffer.

In hindsight, it was an opportunity for investors to buy these stocks at lower levels, but the panic caused by just being in the same sector led to losses for many investors. Cramer adds that high growth momentum stocks act as their own sector. When one falls, the others go down with it.

It is not just the tech sector that has this problem. No sector is spared. Even a steady stock like Clorox (NYSE:CLX) can get sucked into the rotation out of a sector and go down. One must be cautious to detect falls on no news, as these can be buying opportunities.

Addition metrics

Sometimes, the key metrics that control the market change, and one should change with them. If one doesn't change, it will be difficult to find out the reason for the sudden drop in stocks. Since S&P 500 futures drive the market more than individual stocks, it's best to identify the metrics that the market measures to predict the direction of most stocks in the index.

"So, if you think that higher oil correlates with economic growth, then you're most likely to set up a basket of stocks that does well when the economy is accelerating, and you can buy that basket every time oil goes higher," Cramer explained. This basket can have airline stocks that perform well when the economy is strong and people have disposable incomes.

Post this, the complexity of algorithm trading comes into play. As oil price rises, airlines costs rise, which means airline stocks should come under pressure - but they don't. The downside also works. When oil goes down, it suggests that the economy is getting weaker, and hence, the airline stocks go down along with the market, but not as much, since their principal cost is going down.

"The simple fact is that the key metric itself and these algorithmic traders have made owning some groups of stocks beyond mystifying. You could literally own the stock of a company where the earnings estimates are going higher, yet its stock is going lower," said Cramer.

To make sense of the decline in portfolios, one must measure the key metrics like oil, dollar and interest rates. These metrics have the power to impact a portfolio significantly.

ETFs

The popularity of Exchange-Traded Funds, or ETFs, has risen recently, but Cramer doesn't like this trend. Many argue that ETFs prevent against single stock risk, but he disagrees. "You want to be in a stock because it's the best name in a sector that's growing. You don't want to be in a group of mediocre stocks that will pull down the high-quality stock you've chosen," he said.

The "ETF-ization" of stocks happened as people started shying away from single stock risks. Owning ETFs doesn't guarantee profits or safety from broader market trends. "If you think you can't pick the best of these stocks, then I would suggest that you might not know enough about the sector to begin with, so don't think you can outsmart it by picking an ETF," added Cramer.

The exception is the gold ETF (NYSEARCA:GLD), as it trades with the price of the gold and is accurate. "At the end of the day, I'm against ETFs because they often create enormous distortions that can obliterate even the best of stocks. You have to accept a lot more risk if you own a stock that's particularly hostage to a given ETF."

Viewer calls taken by Cramer

What's the adequate number of stocks an individual's portfolio should have? Cramer suggested that an individual portfolio should not have more than 10 stocks. It's better to go for mutual funds instead of investing in over 10 stocks.

What percentage of IRA should be invested in stocks for a retired individual? He suggested having no more than 60% in stocks.

Does it make sense to target companies being acquired for a balanced portfolio? Cramer advised not buying stocks just on a takeover basis unless their fundamentals are good.

Finally, what's an index fund? Buying an index fund keeps you diversified by owning a portion of the total market. For those who do not want to track individual stocks, the Mad Money host suggested investing in an index fund.

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