“The most important rule of trading is to play great defense, not great offense.”
–Paul Tudor Jones, Market Wizard
The Nasdaq Composite is in a 3.2% reaction after peaking seven sessions ago. Shares are now getting in synch with reality following a four-week, low volatility grind higher that appeared as smooth as glass.
Within the list, financial, technology, and retail have outperformed during this reaction in the averages. In particular, retail hit a new relative-strength high on Friday, as did the brokers, while the banks made a new rs high on Thursday. The banks and brokers are viewed as exceedingly important segments to the sustainability of a bull market. Meanwhile, the leaders on the downside have been utility and staples.
This is objective information that tells us that, at this moment, this current reaction should not prove fatal to this bull market. It says nothing about how far the averages correct. An 8%-12% intermediate-term correction is always a possibility at any time in a bull market. Every bull market has a few of them, on average.
And while nothing should ever be relied upon 100%, seeing high-expectation sectors such as retail, financial, and industrial lead the way during this reaction in the averages says that this pullback is not tied to concern over a slowing economy. If that was the case, retail and industrial would be leading the way lower, not higher.
What it appears to be is a garden-variety pullback, whether 3%-5% reaction or 8%-12% correction. It does not come at a bad time for the intermediate-term speculator in high-relative strength titles. Very few of these glamours were approaching attractive entrances anyway, and seeing everything pull back holds out the possibility of new bases, i.e. fresh opportunities, being created in some of these.
In others, the true leaders, new bases may not be created at all. Instead, there may be abbreviated structures – ledges and shelves – where price may be held back by the weak averages like a finger depressing a spring.
This is one scenario.
It is outlined here so that those who expect the true leaders to form pristine six-week bases, just like it says in the textbooks, may be alert for something less obvious.
According to an ancient proverb: He who watches the leaders closely shall have all the information needed to succeed.
Some of the more-speculative numbers such as Solar City (SCTY) and Vipshop Holdings (VIPS), the Chinese discounter of branded apparel, are already off 20%-25% in just the past two weeks. But most are not showing those types of setbacks. In fact, of a list of 78 glamours, just seven are off 15%+.
Of course this could change quickly. Yet it is not as if everything is coming down in sheets, and that the exception is the title that is off less than 10%. For about 73% of glamours stand less than 10% off their recent peaks.
Very few of the current cycle’s speculative growth stock glamours are building bases of five-plus weeks in duration.
Among the names, Financial Engines (FNGN) has earnings estimates of 38%/23% for ‘12/’13, solid accumulation, steady growth in mutual fund sponsors, and an 86 group rs rank. The portfolio management services provider is just two weeks into a new pattern.
This is one of the issues that may not pause to build a five-week-or-more base should the averages continue to base themselves. A tight pattern to keep an eye on.
Green Plains Renewable Energy (GPRE) is thin, at $6.7MM a day in average $ volume. It has big estimates for ‘13/’14 of 57%/65%, and its rs is 99. The group has a 94 rs and the stock is under extreme accumulation. Besides being thin, it is also priced in the teens. A thin teenager. Risk personified. Outside of this, it holds tightly in an eight-day, ascending triangle and should be monitored. A very aggressive player could take this above the recent high of 16.54.
Nexstar Broadcasting Group (NXST) is one of the top one or two issues in the No. 1 group, radio & television. Earnings growth is expected by most analysts to be 31%/174% in ‘13/’14. In five weeks, the television station owner went up 84%. It is now three weeks into a basing process.
Liquidity, at $17.9MM per day on average, is not great. For a very aggressive operator who is comfortable with entrances off of abbreviated ledges, NXST could be explored above its historic high of May 13 at 29.99. A half-sized initial position with a 7% stop loss could be followed up as price moves in the desired direction.
Capital Senior Living (CSU) is an operator of senior living communities with expected earnings growth of 68%/26% for ‘13/’14. The number of mutual fund sponsors increases steadily.
Technically, the stock is forming an 11-week basing pattern. Given the tentative nature of the averages, we would not entertain a cheater entrance above the May 16 high of 27.10 (point “a”). Instead, a traditional base breakout above the Mar. 14 high of 27.90 (point “b”) would make more sense given the general market behavior. A half-sized position could be used with a 7% stop loss.
Acadia Healthcare (ACHC), the provider of psychiatric services, was mentioned favorably here twice in January. Most analysts see 56%/29% for earnings growth in ‘13/’14. Acadia is another name that is almost three weeks into a new base-building process.
In addition to the abbreviated basing pattern with a tight, 9% depth, it is also higher-risk in light of its $11.1MM average dollar volume per day. For very aggressive speculators only, ACHC could be taken above its May 15 high, or 34.98, using a 6%-7% sell stop.
Three D Systems (DDD) needs to spend some time calming its volatility down so it can make another run higher. Along with Tesla (TSLA), DDD may be the most exciting issue among the glamours. The expected earnings growth rate is nothing to write home about (27%/24% for ‘13/’14), but its product, 3-D printers, is by all accounts revolutionary. Its growth rate, then, may be little more than a rough estimate, and subject to upward revision.
Worth watching. Definitely.
Acadia Pharmaceuticals (ACAD) is a very speculative development-stage company focused on central nervous system disorders. ACAD has managed to earn a profit in only one year in the past seven, with more losses expected in ‘13/’14.
Nevertheless, the company’s shares absorbed a recent primary offering well. The stock is working on a nine-day shelf which, for a very aggressive operator, might be taken above the May 20 high of 14.75.
It should be noted that anything less than a five-week pattern will tend to have a harder time offering support in the event a breakout encounters some resistance by sellers.
YY Inc (YY) is a Chinese social communication platform that we mentioned in the Gilmo Report Facebook page a week ago. YY is the highest-ranked rs stock in one of the highest relative strength groups, Internet – Content. Earnings growth is expected to be major, at 61%/66% in ‘13/’14, and sequential quarterly revenue growth is fast.
The stock, which went public at 11 a little more than six months ago, traded as high as 30.09 two weeks ago. Another worth monitoring.
Meanwhile, Pharmacyclics (PCYC) works on a three-month base, a rarity in the growth sector, and is another to keep an eye on.
As might be evident by looking at the names listed above, there are not many issues forming bases. The names listed here are those showing excellent relative strength which might be expected to resume leadership in the event the averages firm up and reach new highs. In light of the lack of opportunities, it should follow, then, that this is not a market to be backing up the truck for.
In summation, shares are in good shape to be entering this reaction/correction. The right sectors are leading: These are high-expectation cyclical issues in retail, financial, industrial, and technology. Meanwhile, the defensives lag, especially the utilities and staples, and also the telecoms.
For the speculator, legitimate five-week-plus basing patterns are few and far between. The aggressive operator should be open to the possibility of the true leaders pausing for only two to four weeks before moving out anew As always, instead of relying on personal opinion or prediction, it is more effective to let the market tell its own story.
Along these lines, it is not necessary to be smart, just smart enough to know the market is smarter.
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