Rule No. 2 tonight is “Know what you own.” Just because you own a tech stock doesn’t mean the company is representative of the entire sector. There are industries within a sector, and those that ignore this important fact can end up losing money – or missing out on big opportunities.
There are times when you’ll see a rally in an entire sector. If the Federal Reserve is cutting rates, almost everything cyclical will get a boost – and cyclicals don’t even comprise a sector, they are a whole bundle of sectors. If the economy has taken a turn for the worse, then you’ll see a jump in the consumer staples, the foods and the beverage companies. These are broad, sector-based rallies, and you don’t have to be all that discerning to pick out a good stock that will make you plenty of money when these things happen, Cramer says.
But most rallies don’t work that way. There will be talk of a healthcare rally or a transports rally or a tech rally, but that doesn’t mean the whole sector’s rallying. (Cramer caveat: Always be suspicious of anyone on TV – except for him – calling a sector rally. You want to know how broad that rally truly is.) It’s the industries within these sectors that really count.
Case in point: Cramer called a tech rally in June of 2005 by writing two ticker symbols on his hands – MSFT and CSCO. He figured these two names best represented tech on the whole, even though the rally was happening in gadget production and not the entire sector. By February of 2006, Microsoft was up over 11% and Cisco was down 3%, while Qualcomm was up 37%, Broadcom was up 87%, Apple up 95%, and Marvell Tech was up 71%. These were the real participants in the so-called tech rally that was really a gadget rally.
Bottom Line: Don’t let yourself be fooled. Your second rule tonight is to never mistake a rally in an industry for a rally in the sector to which it belongs. It’s an easy mistake to make, but if you remember my rule, you should be able to make a lot more money.