STOCKS

Stocks outpacing the broader market in a downturn are often the ones best positioned for new rallies when market conditions improve. MoneyShow’s Kate Stalter zeroes in on two smaller companies showing robust chart action.

As you’d imagine, the heavy-volume selling has narrowed the number of watch-list candidates among equities.

While plenty of market pundits are crowing that now is a time to shop for bargains, I view this environment as too risky for new longs—other than, perhaps, inverse ETFs that I am using as trading vehicles, not medium-term holds.

Although the ranks of technically sound equities has thinned, that doesn’t mean it’s time to quit scouting for potential ideas. Too often, investors remain bearish well beyond the time when markets have resumed their uptrends, and they are not prepared with a watch list of technical leaders.

In early 2010, I overheard a conversation on a plane that illustrates the perils of ignoring market trend shifts. Two passengers sounded almost smug about having gotten out of the market in 2008—most likely, with significant losses—and not having re-entered.

They missed out on the big gains between March 2009 and May 2010! Shifts in trends can yield big opportunities—both on the long and short sides—and should not be ignored.

That’s why I am always attentive to stocks holding up well technically, even when the broader market is under selling pressure. Will all of these watch-list names become winners? Absolutely not. As I noted above, a market-wide downdraft can sweep even so-called “good” stocks lower in its week.

So far in this market downturn, Israel-based chip designer Mellanox (MLNX) has held up better than the majority of stocks. I have written about this stock before, as it’s been a consistent technical leader throughout 2012.

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The stock has been trading in a fairly tight range since late April, holding well above its ten-week line, which, of course, is moving higher. It’s consolidating below an all-time high of $67.20, from April 19.

This is a good example of why it’s not always wise to chase a gap-up. On April 19, when Mellanox bolted 52% following its first-quarter report, the market was in a downturn. There was a brief marketwide rally attempt at the end of April, but it soon fizzled. Mellanox retreated from that high of $67.20.

General market weakness made it more difficult for the stock to hold all its gains. But even in a roaring bull, it’s not unusual for a stock to pull back after a huge price move, as some investors and traders pocket profits.

Mellanox is a very strong watch-list name at this time. Frequently, a stock with good fundamental potential—as is the case with Mellanox—will bide its time while the market is in a downturn.

While the Nasdaq fell 7.2% in May, Mellanox advanced 3.2%. That’s a good sign of a stock that’s ready to make a move, but is being held down by the poor market.

Another such name is SXC Health Solutions (SXCI), which got a boost in April on news it would acquire fellow pharmacy benefits manager Catalyst Health Solutions (CHSI) in a transaction valued at $4.4 billion. As M&A watchers know, it’s not always the case that the acquiring company’s stock gains on the announcement, but that’s what happened here.

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Since then, SXC has consolidated very gradually from its April 20 session high of $100.50. As of mid-session Monday, it was trading at around $86.77, about 14% off that April high.

That’s a sharper rate of correction than the benchmark index during that time, but the orderly decline and ten-week support are keeping me encouraged about this stock’s future prospects. In addition, growth stocks typically correct at a higher rate than the major indices in a market downturn.

SXC is a similar situation to that of Mellanox: Stocks showing solid moving average support and an orderly consolidation at this juncture could be setting up for upside moves in the next market rally.

Be aware: Just because a stock sports a strong record of earnings and revenue growth, along with good estimates, that doesn’t mean it’s necessarily well-positioned at this time.

For example, until the past few weeks, I had been tracking Michael Kors (KORS) and Francesca’s Holdings (FRAN), two clothing retailers from opposite ends of the spectrum, when it comes to the consumer each is targeting.

Both of these recent IPOs are trading below key moving averages, and are still too technically weak to even hint at potential run-ups yet. On a fundamental basis, those stocks are still landing on my earnings and revenue growth screens, but as of now, they are not in the same league as names such as Mellanox and SXC.

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Tickers Mentioned: Tickers: MLNX, SXCI, CHSI, KORS, FRAN

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