–– Chinese Proverb
Historically, there have been an average of two particularly auspicious times to buy stock each year. The current period is considered another such opportunity.
Many shares build and break out of bases. In and of itself, this is the most bullish thing a share market can do.
To review, the backdrop changed for the better when the ECB decided to add liquidity. At the time, this development meant little to us, as the market itself had not rendered its verdict with any conviction. What meant more was seeing the major accumulation days of Jan. 17-18, as noted in the below chart.
Indeed, it was the Jan. 17 session that said it was time for the intermediate-term speculator to begin to wade back into the market, as noted here on that day. At that point, there still was not enough real speculation evident in the market to warrant a fully-invested position. Translation: Up to that point, the breakouts 1) had been in the more-conservative growth numbers, like Dollar Tree (DLTR), and 2) the volume accompanying the breakouts and the follow-throughs post-breakout were unimpressive, with virtually none showing the 20%-25% follow-through that is a favored litmus test of the speculative sentiment’s legitimacy.
One could have gotten aggressively long early in January, or even at mid-month, but the handwriting was not on the wall at that point.
Since then, of course, the breakouts and accumulative behavior of the more-speculative titles have provided the clue that this was the real McCoy, something to be played.
It is to be noted that these reports are based 100% upon the market’s action, and 0% on personal opinion or prediction. There are no crystal balls here, nor does there need to be. The trend-following strategy spoken about since the inception of these reports 19 years ago has been altered very little. We look for an uptrend in the averages that is institutionally supported, meaning that it is volume-backed, and then we target those titles that are outperforming the rest of the market, preferably as they clear basing areas, or areas of sideways consolidation following an advance.
Shares like these have correlated well with the market’s biggest-winning stocks, according to research conducted by Bill O’Neil in the early-‘Sixties. We do not spend time analyzing the fundamentals of a company, other than knowing what the Street’s earnings growth estimates are. We are only interested in what is working now in the market, i.e. the relative-strength leaders. A loss, when incurred, is limited to about 5%-7%, unless a junior position is used, in which case the loss can run a bit longer because it is one-half the size of a normal position.
We do not argue with the tape, and when the market is in a stiff intermediate-term correction or outright bear market, a 100% cash position is used to protect precious capital. This is what separates this strategy from some other trend-following strategies, which can incur large drawdowns in capital due to their having to sit through bear markets.
This is not to say that this strategy is for everyone. There is no single strategy that is best for every investor. For example, some participants do not have the time to devote to this strategy, nor the interest.
Among the names, Rackspace Hosting (RAX) noted here on Dec. 18 (“…the Nov. 8 high of 45.46 could be used as a potential entry pivot for RAX“), broke out Feb. 2 on volume 184% above normal, with five of the next nine trading days occurring on major accumulation. Tuesday’s 13% move on volume 480% above average speaks of strong institutional interest. This title is one of the four or so that we believe has the greatest potential to become one of the outstanding leaders of this bull market. This view can change at any moment, and flexibility is our middle name. The things that we especially like about RAX are the 47%/44% earnings growth estimates by the Street for ’12/’13 and the rich valuation (about twice its forward growth rate). At present, the stock is extended and not attractive for entry.
(Over the decades, most of the market’s biggest-winning stocks have possessed rich valuations, hence our interest in these names. Granted, more risk comes with them, especially the risk of an earnings-related blow-up that can take a stock down 20% or more overnight. But again, this is one of the things that has correlated with the biggest gainers in history, not to mention those of our account. If you are an aggressive speculator, you will want to focus on the best-performing stocks right now, not the ones which sell at discounted valuations to the market.)
Netsuite (N) is another that has the potential to be an outstanding leader in this cycle. Earnings estimates are 40%/62% for ’12/’13, the valuation is rich, and Q4 earnings have already been released. Technically, the stock is forming a handle to go with its cup-shaped base. A possible entry above the Feb. 3 high at 48.82, preferably on big volume, could be considered by an aggressive speculator.
Priceline.com (PCLN) noted in the Feb. 2 MarketWatch column as a stock that was buyable “with a potential entry point above its all-time high of 561.88,” broke out above this level Monday on volume 75% above average. For those who missed this, we would prefer to wait for the stock to pull back from here before entry. As well, earnings are to be released later this month, though we would not allow this to get in the way of an entry, should price pull back.
Zillow (Z), noted in our Jan. 31 report as “perhaps the best-looking of the recent-vintage, Internet glamours.” lives up to this billing, but does not yet warrant entry. Earnings are to be released imminently. We like the 155% earnings growth estimate for ’12 by the Street, and the revenue acceleration growth over the past four quarters of 49%, 104%, 111%, 116%, and 132%. The number of mutual funds owning the stock rose from 99 to 125 in the latest quarter. Fundamentally, this has all the makings of an outstanding leader.
Technically, the stock is under extreme accumulation, and we would watch this closely to see how it behaves after its earnings release. Price has not offered us much of a pullback over the past dozen sessions, much like the Nasdaq itself. Shades of the ‘Nineties here.
Linkedin (LNKD) is another of the few that we believe have the credentials to become outstanding leaders in this cycle. Earnings growth estimates are for 77%/76% in ’12/’13, about as thick as any other growth stock in this market, the valuation is rich. A potential entry for the aggressive speculator would be above the Friday high of 91.20, preferably on strong volume. The usual stop loss of 5%-7% should be used if proven incorrect.
Mercadolibre (MELI) has the earnings estimate we like to see (32% for ’12) and technically is forming a classic cup-with-handle base. The potential entry point would be a takeout of the high of the handle at 98.75, as shown in the below chart. Earnings are due out later this month.
Elsewhere, Freescale Semiconductor (FSL) may be interesting above the Feb. 3 high of 17.84. It should be noted that, technically, this is a not a growth stock, and is also a teen-ager in price, and hence carries more risk.
Pandora Media (P) is also worth watching. In summation, the averages are extended and overdue for a 3%-5% reaction, at minimum. Many stocks are building and breaking out of bases, the most bullish development type of indication. The speculator who seeks to be in winning stocks for several weeks to several months is advised to focus on the market’s action, and not one’s own opinion. This means buying the breakouts as they present themselves, despite the market being extended. A protective stop-loss should be used on every trade to mitigate risk of being incorrect.
Trade what you see happening, not what you believe may happen.