But before I reveal my screen criteria, I want to show you why I believe we’re entering an important moment for small stock investors…

Right now, the market is beginning a powerful underground rally, boosting small-cap stocks close to their pre-correction highs. The Russell 2000 is up more than 11% year-to-date, easily topping large-caps in the S&P 500 and the Dow.

Small-caps are winning the race right now because they are the most potent stocks to own during the early stages of a rally. As you probably know, investors see small-caps as riskier investments. That’s why they are the first to be sold off after a long bull market.

But small-caps are also the first stocks to rise once the market has bottomed out. The rush to get back into smaller names pushes these same stocks up farther and faster than their larger counterparts.

Even though small-caps are outperforming the S&P 500 and the Dow so far this year, we haven’t seen a watershed buying moment just yet. That’s why I’m still calling this an “underground” rally. But with every passing day, I think we’re getting closer to that powerful breakout. All that’s left to do is to coax investors on the sidelines back into small stocks.

Retail investors have pulled almost $18 billion out of small-cap funds over the 36 of the last 39 weeks, according to data from J.P. Morgan. This shows us that a great deal of Main Street’s money is still in cash, waiting until the investing waters are declared safe before buying smaller stocks. All we need is volatility to remain low and the market to remain stable for these market watchers to dive back into stocks.

That’s where my 3-part screen comes into play. Follow these easy steps, and you will be able to track down the small stocks that are the best candidates to beat the market. If you do it today, you’ll even have the chance to get in on these names before the next leg of the rally begins to take off…

To begin, go to your favorite free financial website. Google Finance, Yahoo or any of the other major sites will do. If you want a more comprehensive list of screening tools, just search for “stock screeners” online. There are plenty of viable options out there. You don’t even need a subscription or any special software.

[Editor’s note: For a more in-depth piece on free stock screening sites, click here.]

Now you’re ready to begin your search.

1. First, drill down to the most viable sectors: Right now, the investing environment is most suited for consumer stocks, tech names, and pharmaceuticals. These are the types of small-cap stocks that are looking strong right now. Get rid of stocks in the utilities, energy and financial sectors. These are the names that aren’t showing strong earnings or growth at the moment. There’s no point in wasting your time sifting through stocks in a lagging sector. Cut them, and move on.

Setting up the screen is simple. Just adjust your market cap parameters to find stocks in the $300 million – $2 billion range. Then you can enter your sector of choice…

2. Find the profitable companies trading at a low price-to-earnings ratio: The next metric you need to add is price-to-earnings ratio. Investing in companies that are cheap compared to how much money they are earning is a great way to prepare for a rally. Filtering out stocks with P/E ratios higher than 15 is the perfect way to narrow your search. When stocks are moving higher, bargain hunters will swoop in and bid up these “cheap stocks” to more reasonable levels.

Now that you’ve added this second key metric, you can begin searching your selected sectors for cheap plays. Make a list of all the companies that interest you. Now you’re ready for the final step…

3. Finally, select the stocks with the most momentum potential: Your final step involves some quick chart analysis. But don’t worry—you do not have to be seasoned market technician to complete this task. Simply take your list and look at each company’s daily chart. Then ask yourself one simple question: What is the primary direction of this stock?

There are three answers to this question: up, down, and sideways. Get rid of any stock that looks like it is moving lower. That will leave you with names that have bottomed out and are moving sideways, and stocks that are moving higher. As you narrow your list, you can use these charts to separate your best ideas. If you have two stocks you really like, compare charts. Unless you have a compelling reason to pick one name over another, I would recommend going with the stock in an uptrend every time.

Here are a couple of examples I found after searching for only 10 minutes:

Iconix Brand Group Inc. (NASDAQ:ICON): Iconix owns a large portfolio of apparel brands. Its P/E comes in at about 13, and the company has proven it can steadily increase its sales and earnings. The stock has also moved steadily higher since it bottomed in early October.

Greatbatch Inc. (NYSE:GB): Greatbach is in the medical device sector. Its P/E comes in at 14. The stock is also only slightly above sales—another sign of a cheap name. GB is also recovering from last year’s slump. Shares are quickly approaching pre-correction highs.

Of course, this lightning-fast analysis just scratches the surface of these two companies. Still, you can see how a quick search yielded two strong possible investments.

Sincerely,

Greg Guenthner
for The Penny Sleuth

3 Keys to Playing the Underground Small-cap Rally was originally featured in the Penny Sleuth.

It’s the rule that every successful investor has used to build wealth. And it’s the same rule that will destroy your trading account if you fail to heed its warning.

That’s why I want to alert you to a group of stocks that could cause you a lot of unnecessary pain this year. I’m talking about the so-called social gaming sector — specifically Zynga Inc. (NASDAQ:ZNGA) — the developer of FarmVille and other fad games for Facebook and mobile phones.

It all comes down to unrealistic expectations. I saw this same story play out last year when OpenTable Inc. (NASDAQ:OPEN) and Green Mountain Coffee Roasters (NASDAQ:GMCR). Both lost more than half their market value after failing to meet outrageous growth projections. The same fate awaits Zynga. If you invest in this stock expecting a huge payout by next year, you could be in for a terrible surprise.

Here’s why you need to avoid this stock — and the entire social gaming sector…

Since Facebook formally submitted its IPO paperwork last week, analysts and investors have been buzzing about Zynga’s growth prospects, bidding the stock up nearly 40% in a little more than a week. But I don’t see this growth story playing out much longer without a serious correction.

Unfortunately, countless eager investors will probably get sucked into this stock before it crumbles. It will begin next week when Zynga will announce fantastic earnings. The company will beat estimates, predict incredible growth and win over plenty of new followers. Yet despite the hype, Zynga will eventually disappoint anyone who buys this stock right now. In fact, the entire social gaming sector is a sham. And it will quickly unravel once investors realize Zynga and its peers can’t live up to the lofty expectations…

Of course, this hasn’t stopped the financial media from highlighting some gaudy numbers. Analysts have even reverse engineered Facebook’s recent IPO filing to predict Zynga’s performance. Since Facebook reported that Zynga was responsible for 12% of its revenue, it’s easy to see that its game sales were worth $450 million to the social networking giant last year. One analyst who dissected the report even raised his fourth quarter revenue forecast for Zynga to $315 million from $300 million…

That’s a considerable amount of money. However, I don’t think the good times will last.

There are simply too many factors working against Zynga and the social gaming sector. Just because of the nature of the business, it will be incredibly difficult for Zynga to protect its current position at the top of the industry. Simply put, there’s nothing standing in the way of a garage-based start-up from destroying Zynga’s market share. It doesn’t take tens of millions of dollars to put together a game development operation and release a title.

Innovative start-ups could quickly pose major problems…

These pesky start-ups aren’t the only threat. Established video game companies are also fighting for their piece of the social gaming pie. Even video game giant Electronic Arts Inc. (NASDAQ:EA) has emerged as a Zynga competitor. As if we needed more proof that the EA threat is very real, Zynga went on the offensive last month and hired away the head of EA’s interactive division. This is the kind of poaching I expect from this sector. In the end, none of these firms will walk away with enough of an advantage to be a staying force in the industry. In the long run, they will continue to cannibalize sales from one another, leaving no possible way for the average investor to capitalize.

Furthermore, games that are popular now won’t stay popular forever. I do not believe social gamers are going to be loyal to one game developer or another. They will play the “hottest” game at any given moment, and then move on to the next-best title once it becomes available. Zynga is bound to miss the mark with one of its upcoming games. That’s all it will take for investors to head for the exits. Just one mediocre launch that falls short of expectations will send the stock into a tailspin…

Right now, analysts are betting big on Zynga’s foray into gambling-related games. But I’m not willing to take these odds. I’m seeing better opportunities (with far less risk) elsewhere in this market. I’ll highlight some of these soon. For now, steer clear of Zynga and social gaming. As investments, these stocks just don’t make a whole lot of sense.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Why You Should Avoid Zynga and the Sham “Social Gaming” Sector was originally featured in the Penny Sleuth.

But before I get into the details, let me explain why I’ve been so reluctant to take a serious look at any Chinese stock, even those trading on major U.S. exchanges…

For almost a year, I’ve honored a self-imposed ban on the purchase of any Chinese stocks. I haven’t touched a single Chinese ADR since my ban — and I haven’t recommended a single one to my readers.

The saga began last year with a small Chinese travel stock called Universal Travel Group (NYSE:UTA). Back in September 2010, I recommended shares of the small-cap Chinese travel company to my readers, pinning hopes on a dirt-cheap valuation and breakneck growth in the Chinese travel industry. But the morning after I sent out the recommendation, a short seller published a report detailing why UTA was a fraud and why he was actively betting against shares. The stock opened for trading down 30%, and we quickly sent out an alert for readers to sit tight before buying while we investigated the claims.

After some digging, I felt the claims boiled down to a misunderstanding of the company’s business. Every argument for UTA being a fraud looked incorrect. Luckily, we were able to take advantage of the situation, re-issue the buy recommendation — and even ended up booking gains on the investment.

Even though we did well on the UTA investment, we were concerned about the power that unknown short sellers could have over Chinese ADRs. While there had been some rumblings about the abundance of fraud in China, UTA was one of the first major short attacks on a Chinese stock.

Then the floodgates opened. Fraud allegations appeared left and right. And short sellers eventually targeted another one of my recommendations, Advanced Battery Technologies (PINK:ABAT).

ABAT was a Chinese battery stock I recommended back in March 2010. It was up as much as 21% early last year — but that was before another short attack shoved shares more than 40% lower in a single trading day. I ended up closing the position for a loss — but was spared the 90% drop that eventually crushed the stock.

That’s when my ban went into effect. Even if Chinese fraud wasn’t truly widespread, the risks of a short attack were just too real to justify buying any of these ADRs — no matter how rosy the growth picture may have been at the time. Investors were eating up every fraud report that hit the web. There was no telling what stock would be the next target —or if the claims of fraud would even be legitimate…

But now, something has changed. I’ve found this new growth market in China that could have the potential to deliver early investors significant gains. It has the potential to be so powerful, in fact, that it could easily repel short attacks just like the ones I’ve experienced firsthand…

I’m talking about the Chinese pharmaceutical market. It’s growing faster than any other drug market on the planet right now, with some projections expecting it to balloon to $115 billion in the next three years.

Here’s the kicker: Because the Chinese government requires local testing of medicines — and because the cost for conducting the animal research to perform these tests is about half what it is in the U.S., domestic companies are beating down the doors of these Chinese drug research firms. They want to get their foot in the door so they can grab some of the profits of this red-hot growth market.

Because these Chinese-based firms are now buyout targets for major U.S. Pharmaceutical firms, we now have an extra margin of safety while exploring the sector for potential investments. If Big Pharma has sent its best people to China to investigate these businesses and their growth claims, I sincerely doubt a short-selling raid would hold up to the scrutiny.

That’s why the small-cap ADR WuXi PharmaTech Inc. (NYSE:WX) has caught my eye. Not only does WuXi grab 70% of its revenue from research for U.S. companies, it also was involved in a “near miss” $1.6 billion takeover attempt from U.S.-based Charles River Labs, according to Bloomberg. The only reason the deal went sour is because Charles River shareholders voted it down because they felt the premium was too high.

In my view, this was a huge mistake made by short-sighted Charles River shareholders…

A precedent was set by the offer — which represents a premium of more than 60% above WuXi’s market value right now. Analysts don’t see the company accepting anything less. Frankly, neither do I. WuXi is simply making too much money — and monopolizing too much U.S. business — to humor a lowball offer. According to data compiled by Bloomberg, WuXi’s profit margins are 5 times that of its U.S. counterparts. WuXi is eating their lunch, and they know it.

A buyout offer is not a matter of “if” but “when” at this point. Someone will come along with a massive offer for WuXi — or even one if its competitors in the research sector. An event like this should trigger a ton of activity in the sector. And anyone with the foresight to see the big buyout on the horizon stands to capitalize on the action.

Sincerely,

Greg Guenthner
for The Penny Sleuth

The Only Chinese Growth Story Worth Buying Right Now was originally featured in the Penny Sleuth.

We’ve entered a high-stakes election year, where the market should cycle into strength as those in power attempt to win the hearts and minds of the electorate…

The slow-burn of the Eurozone crisis is also beginning to fade. Negative headlines and poor economic data — the exact same information that paralyzed investors just a few weeks ago — just don’t seem to matter anymore…

Some analysts (including a few of my colleagues) are attributing recent market strength to the Facebook effect. But I’m not completely sold on this explanation at all. Your mom and her friends talking about the Facebook IPO does not trigger a broad market rally. Sure, stocks in similar sectors will see some buying. But no one is bidding up shares of Waste Management in anticipation of Facebook going public.

However, Facebook’s impending offering is a symptom of the market rally itself. The billionaires and soon-to-be billionaires behind the IPO weren’t going to float this stock to the general public while the rest of the market was having a fire sale. That’s not good business. Waiting until the market has its legs back will always trigger a rush of offerings that have been patiently waiting in the wings — this one just happens to be a biggie.

But it doesn’t matter who is right — it all comes down to this: the bears might win today or tomorrow, or even most of next week. But ultimately, they will suffer as stocks continue to rally, sparking short-covering that will push the market up even faster…

That’s the thing with early-stage market rallies. Buying is contagious. And when it spreads, those on the wrong side of the coin are unceremoniously slaughtered. The euphoria of stocks moving higher after months of declines lobotomizes traders. They will jump on the big move, shoving aside anyone who gets in their way.

Of course, this is not a friendly game. At the beginning of a new trend, there are winners — and losers. If you don’t properly position yourself in the early stages of a rally, you will lose. It’s a simple as that…

If you’re buying stocks that are the strongest movers off the market’s lows — with the intention of holding them — you could be setting yourself up for failure. These stocks that catch fire and outperform during an initial broad rally are usually the most heavily-oversold names on the market. Most of the time, it’s because these stocks don’t have the fundamentals to backstop any intense selling pressure.

To put this into perspective, take a look at this chart of Response Genetics Inc. from 2009:

RGDX is a micro-cap biotech with no earnings and very few assets. The stock jumped big in March 2009 as the broad market put in a bottom, but the rally couldn’t hold. Investors moved on to other stocks that offered a stronger financial cushion.

Fast forward to present day, and we’re seeing similar action in RGDX:

After a sharp selloff in 2011, RGDX is roaring back to life. But while this stock might make a fine day-trade, I don’t see it holding up as a viable medium- to long-term investment. History could very well repeat itself here — with RGDX ending up back at $1 before the market runs out of steam.

On the other hand, the stocks you can find that will ride this emerging rally will have the backing of solid fundamentals and tangible industry trends. You’ll still have the upside of an in-favor stock — but your risk will be mitigated by revenue and earnings growth and the powerful economic conditions that drive the particular sector or industry.

The week before Christmas, I laid out three major stock trends that I believed would shape the market in 2012. The first major trend revolves around a slew of pharmaceutical patents that are set to expire this year. That means Pharma stocks that are favorably positioned in the generics business should easily outperform the market.

Here’s one of the fastest-growing, profitable small-caps in the generic drug industry:

Akorn Inc. (NASDAQ:AKRX) might not be one of the best performing stocks so far this year. However, the stock continues to build on its market-beating trend from 2011 while the business consistently grows its profits and raises guidance. That’s why I recommended this stock to my readers last year — and why we’re still holding the stock today.

If you continue to seek out stocks like AKRX that have strong fundamentals and a steady, rising trend, you should have no problem avoiding the garbage stocks that sucker in so many investors during the early stages of a bull market rally…

Sincerely,

Greg Guenthner
for The Penny Sleuth

Finding an Edge When the Market Moves Higher was originally featured in the Penny Sleuth.

As a group, social media stocks have thus far been a rather unimpressive group…

Linkedin Corp. (NYSE:LNKD) continues to find lower ground after its 2011 IPO (it’s currently down more than 21% from its first-day price). Daily deal provider Groupon Inc. (NASDAQ:GRPN) is performing even worse — it’s down more than 25% from its IPO high. Even the Social game maker Zynga Inc. (NASDAQ:ZNGA) is still shy of crawling back up to its IPO day high of $11.50.

However, all will be forgiven once Facebook is finally on the market — at least, that’s what some in the financial media would have you believe…

Late last week, we learned that Facebook is finally preparing to file its initial public offering which could raise as much as $10 billion. The offering will place the value of the social networking site somewhere between $75 billion and $100 billion. The $10 billion IPO alone easily places Facebook among the largest offerings of all time — and the biggest U.S. internet IPO by leaps and bounds.

For some perspective, Google’s 2004 IPO netted the search engine (and now-Facebook rival) what now seems like a paltry $1.2 billion.

But what if investors aren’t so eager to own a stake in The Social Network? What if —after a couple of high-flying weeks — the stock begins to fall? Or even worse — what if it tumbles right out of the starting block?

While I can’t try to predict the trend of a stock that does not yet exist, I can tell you this: If shares of Facebook fail to deliver reasonable gains, this new stock will cut down every other stock in the so-called social media sector. After all, if the biggest and best example of the group fails the investor’s litmus test, how can the others expect to outperform the market?

Needless to say, I don’t recommend buying these stocks. Even without the specter of Facebook looming over the industry, there’s too many unknown factors at work. First, these IPOs have no trading history- and therefore no chart to refer back to. This makes it difficult to gauge sentiment, or what the important emotional price points of the stock will be.

Second, there are major shareholders and big money investors who will probably be selling their shares for a quick buck, especially if the stock debuts higher than its pre-IPO price, which most higher-profile IPOs often do. This has a tendency to drive the share price down even after an initial spike as these early investors sell their shares.

Obviously, the financial media — and even the mainstream media — tend to fall all over the bigger name IPOs, especially these household name companies that are working to go public. Don’t buy into the hype right away…you could get burned.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Facebook’s IPO Could Cripple the Social Media Market was originally featured in the Penny Sleuth.

We should continue to expect this tug-of-war between bulls and bears to continue for a while as the market approaches important areas of resistance. The emotional game has to play out — and you’ll have to wait and see what side wins over the hearts and minds of the market and its many participants.

Simply put, it is dangerous to “take sides” this early in a trend. For instance, traders were buying stock early this week as if it were their last day on Earth. Unfortunately, the buying didn’t stick, and most stocks have found lower ground. Expectations went from bullish euphoria to an almost unanimous consensus that a pullback was in order in just a few days.

None of this back-and-forth action is cause for alarm. Stocks have been climbing steadily for weeks now, so we will eventually need to see some sort of correction. This can happen one of two ways — through price or time. While there is no way to say for sure how the market will digest its strong start to the year, it appears that stocks want to churn sideways for a bit.

For now, a sideways market makes sense. Despite the strong start to 2012, I do not believe the investing public is getting too greedy at this point. But it is fairly evident that at least some level of comfort is returning to the markets. So we’ll walk the tightrope of fear while the major indexes sneak toward important areas of resistance. That’s where things will get interesting…

The Dow is already extremely close to matching its 2011 highs — and the S&P isn’t far behind. Here’s a weekly look at both indexes, with areas of resistance marked with dotted blue lines:

How investors react to these key levels will determine the strength of the rally over the next few weeks. Obviously, a clean break of the previous highs will help put the past 6 months behind us. With clear skies ahead, we should see additional interest in smaller stocks — and more trading opportunites in the small-cap and microcap universe.

What’s important right now is to train yourself to be able to see the forest through the trees. So many traders get hung up on the day-to-day movements of the market, letting their emotions get swept back and forth with every high and low. Micro-analysis like this can lead to chasing stocks, bad entries and exits, and losses. But even more importantly, if you let the tiny movements of the market get in your head — especially duing important turning points in trend — you’ll risk missing the bigger move entirely.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Don’t Get Trapped By Sideways Stocks was originally featured in the Penny Sleuth.

Often, the momentum can be traced back to an obvious catalyst — fundamental improvements within the group or a well-publicized buyout in the sector. But sometimes, investors and traders trigger a furious rally pinned on nothing but the simple fact that a stock has started to move in their favor. The buying triggers even more buying — and the rally begins to feed off itself.

I’ve chronicled several interesting rallies over the past few years, ranging from coffee stocks (slightly absurd) to semiconductors (a great cyclical growth story). Eventually, these rallies run their course, and momentum traders move on to the next best thing. That might be happening right now to “The Great Pizza Rally of 2011-12.”

This pizza rally has been interesting for a couple of reasons. First, it has been largely contained within a subsection of the fast-food industry that would rarely be classified as a growth market. Also, I can see how a buyer might justify the rally in his mind. After all, the economy isn’t in great shape, so the average family might be buying more pizza. It’s a weak argument, but it makes sense to those who don’t trade using technical indicators. It’s tangible, easy to understand and act upon, and reinforced by the media.

Today, we’ll take a look at a couple of pizza players — and a few other high-flying stocks — and try to predict what the future holds for each…

Pizza Inn Inc. (NASDAQ:PZZI): This small pizza chain saw a big rally in its stock, taking shares from $3.50 in October to almost $7 by the beginning of December. Now, it looks as if the stock is stuck in the $5.50 range and possibly heading lower. The sharp uptrend that began in the fall is broken, so you shouldn’t expect more upside from this name anytime soon:

Domino’s Pizza Inc. (NYSE:DPZ): The king of pizza delivery is showing us a very similar pattern. Once again, we have a nice fall rally, lifting shares from $26 to $35 in a matter of weeks. However, 2012 has not been as kind to Domino’s. While the broad market has rallied to post-correction highs, DPZ has fallen out of favor. You can clearly see the trendline break right at the beginning of January:

BroadVision Inc. (NASDAQ:BVSN): After failing to catch a bid for most of 2011, BVSN proves that you don’t need a reason for an unannounced, triple-digit rally. This unheralded microcap started the month as a $10 stock, only to top $44 by yesterday afternoon. Not bad for a few weeks work — and absolutely no news other than the sheer power of the rally itself.

But that’s the thing with moves like this: they have to end eventually. And when they do, look out below. Check out the chart below for a very clear picture of what an unsustainable rally looks like. You should expect further downside action from here:

Apple Inc. (NASDAQ:AAPL): Finally, we turn to last night’s earning surprise from Apple. Even without vaunted leader Steve Jobs at the helm, Apple reported record earnings on stronger than expected iPhone sales. Spurred on by a 6% move this morning, Apple once again overtakes Exxon Mobile Corp. as the biggest company trading on the U.S. markets, with a market cap approaching $417 billion:

Sincerely,

Greg Guenthner
for The Penny Sleuth

Today’s Market Movers: AAPL, BVSN, and the Great Pizza Rally was originally featured in the Penny Sleuth.

While there is no set formula that can tell you if and when a breakout has staying power, you can interpret how investor behavior might hold back a strong bull move — or aid stocks in their search for higher ground…

Switching Gears

First, you have to understand that a massive attitude shift must take place in order for stocks to alter their trend. Bull and bear trends generally are more likely to continue rather than suddenly reverse course. Think of it as you would Newton’s first law of motion: objects in motion tend to stay in motion, unless some outside force interferes.

In the case of trends, interference can be a variety of events or circumstances — and will rarely be a cut-and-dry, immediate stop-and-reverse. The market is much more nuanced than that…

Let’s take a moment here to consider the beginning of a new trend in the S&P 500:

Everything appears to be setting up favorably on the chart. We have a series of higher lows since the October bottom, and shares have finally topped 1,300 — just above the previous highs.

But have investors’ attitudes switched to bull market thinking?

Market participants need to switch their mindsets if they truly believe the market will go higher from here. Right now, for such a clean break in the S&P, we’re not seeing a lot of follow-though buying. Investors continue to sell after big moves — because they remain stuck in a bear-market frame of mind. I can’t tell you when the watershed moment will arrive, but I can tell you how to spot it: When investors begin to chase rallies, you can expect some follow-through from the market.

It’s all about fear. The fear of losing money is replaced by the fear of missing a big move higher. That’s a major ingredient in the making of a new uptrend…

What’s In Favor?

Small stocks underperformed their blue-chip peers in 2011. This isn’t so shocking when you factor in market volatility during the second half of the year. Investors were spooked over the possibility of a deeper correction — causing a flight to safety to the bigger, dividend-paying names.

In order for a new bull market to gain traction, we want to see investors begin to favor the riskier asset classes — such as small-caps. To some extent, this has already happened. The Dow is up about 3.75% to start the year, while the S&P has risen almost 4.25%. On the other hand, the Russell 2000 — an index that reflects small-cap performance — is up almost 5.5% in 2012.

This is a strong sign for the bulls. If small-caps can maintain their lead over the broad market, traders and investors will feel much more confident in the new trend.

Garbage Stocks Change Course

Another key ingredient to a broad move is the inclusion of stocks that were abandoned during the previous period of market turmoil. Analysis from Bespoke Investment Group shows out-of-favor stocks from 2011 are outperforming the names that held up well during the correction:

“The 50 S&P 500 stocks that did the best in 2011 are up an average of 2.1% so far this year. The next best group of 50 stocks in 2011 are up an average of just 1.1% in 2012… On the other hand, the 50 stocks that did the worst in 2011 are up an average of 11.2% in 2012.”

So investors are not only increasing their risk appetite with smaller stocks — they’re also loading up on the names that burned longs left and right just months ago. Ill-advised or not, picking up shares of bottom feeders and seeing them break their nasty downtrends can only help restore confidence in the stock market…

It could remain a bumpy ride in the near-term, yet I will remain cautiously optimistic that this new rally might stick. With a few clearer signals and some emotional adjustments of the investing public, the floodgates could open for a new bull market.

Sincerely,

Greg Guenthner
for The Penny Sleuth

How Investor Confidence Shapes A New Rally was originally featured in the Penny Sleuth.

As much as I want to be bullish here, I’m still a little spooked by this market and what has become the longest, more boring economic crisis in the history of mankind. As much as the slow-motion eurozone meltdown has fallen off the front page, its potential threat as a wrench in the market’s gears is still very real.

With that in mind, I’m going to take a look at several stocks fighting to break out this week. All of these names are at or near important resistance levels…

A couple of notes about resistance before we go to the charts: First, resistance is an area, not a cut-and-dry line as it’s most often depicted. Also, many stocks have multiple areas of resistance — some more important than others. For all of the stocks I’m featuring today, a resistance break could signal the start of a new uptrend. Or it could fail and knock the stock back to into its trading range.

The bottom line is that you need to prepare to go long — but also be ready for disappointment if the market tells you its gains to start the year are too much to handle right now. Don’t try to anticipate a big move — let the market come to you…

Freescale Semiconductor Inc. (NYSE:FSL): FSL has a nice look to it right now. We’re seeing a very strong move this afternoon, but the stock is pulling back from its highs. It will need to close above $14.70 to prove the buying power behind it wants shares to trade higher. Look at the long wicks poking above resistance on the chart below. These are two other attempts to hold $14 that failed in the past three months. If you tried to buy on the intraday break, you would have been stuck with a losing trade:

Oasis Petroleum Inc. (NYSE:OAS): Oasis is another name that popped at the open, only to endure a steady sell-off as the day progresses. A hold of $34 is crucial to keep this stock’s momentum intact:

Network Engines Inc. (NASDAQ:NEI): Here’s an interesting microcap to keep an eye on. A big jump from $1 to $1.25 to start the year might be weighing on shares right now. The stock consolidated for more than a week, and shares are now eying strong resistance at $1.30. I would recommend waiting for more convincing evidence that this stock is primed for another run. Look for a volume spike to coincide with any swing to the upside. If the volume confirmation isn’t there, stay away from this one:

Penny Promotions

[Editor’s note: In this section of Market Movers, we expose stocks that are currently the subject of promotional material. If you’re unfamiliar with promotions, pumps and dumps, or other penny stock scams, please take the time to read this column before continuing. Unless you are an experienced trader, we recommend that you avoid these stocks at any price.]

Stevia Corp. (OTC:STEV): Stevia has been pumped before in print mailers — and now I’m seeing the stock make yet another monster move — 150% in just 2 days. I haven’t seen the new promotional material for this go-round, but I’m all but certain Stevia shares aren’t moving that far, that fast all on their own. I would not be surprised to see this stock back below $1 in short order…

North Springs Resources Corp. (OTC:NSRS): If I never see this ticker again, it will be too soon. During the first two and a half weeks of 2012, my spam filter has nabbed countless NSRS promotions. It feels as if every pumper in the country has been assigned this stock — and they’re going to make sure the company gets its money’s worth.

Unfortunately, I don’t think this stock is going to go quietly into the night. Judging by how the chart is setting up, I’m guessing that this could be a longer-term pump — much like we saw from Jammin Java Corp. (OTC:JAMN) early last year. We’re probably in store for multiple shakeouts and re-pumps, culminating in one devastating drop. But that’s just a guess. It’s impossible to know exactly what the manipulators have in mind, which is what makes stocks like this so dangerous to trade.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Today’s Market Movers: FSL, OAS, NEI, STEV, NSRS was originally featured in the Penny Sleuth.

But the top-line boost of a promising biotech acquisition doesn’t come cheap. Yesterday, I highlighted the Bristol-Myers Squibb purchase of Inhibitex (NASDAQ: INHX) for $2.5 billion, a premium of more than double the company’s market cap at the time. The deal landed shareholders overnight gains approaching 125%.

If the market remains this competitive for quality acquisitions, small-cap traders and investors should have numerous opportunities to cash in on the trend. Several large-cap pharma players have indicated they are actively looking toward acquisitions to fuel growth. Generic-drug making giant Teva Pharmaceutical Industries Ltd. (NASDAQ: TEVA) told Bloomberg that the company is looking for potential deals in Asia and Brazil to improve its position in emerging markets. Merck & Co. (NYSE: MRK) has also thrown its hat in the ring. The company recently told the Wall Street Journal about its desire to make key acquisitions in a quest to solidify its spot in the Hep C market.

In an effort to help narrow your search, I’ve compiled a short list of potential small-cap buyout candidates that are all involved in Hep C drug development . Any one of these small-caps would be an excellent target for a major pharmaceutical firm looking to bolster its patent portfolio or capture market share in this emerging sector. Hep C medications are an important area of focus right now as pharmaceutical players attempt to favorably position themselves within the growing sector. And it’s also one of the best places to look for potential deals…

Idenix Pharmaceuticals Inc. (NASDAQ: IDIX) – The Inhibitex/Bristol-Meyers deal revolved around the company’s unique Hepatitis C treatments. Also, in this sub-sector, we’ve seen Gilead Sciences Inc. (NASDAQ: GILD) plan a $11 billion purchase of Pharmasset Inc. (NASDAQ: VRUS). That’s why it would be wise to keep Idenix Pharmaceuticals on your radar. The stock popped double-digits earlier this week thanks partly to the Inhibitex deal— and partly because the company released positive interim data for its own Hep C drug. I would not be surprised if additional rumors related to multiple Big Pharma suitors were to emerge in the coming weeks and months.

Achillion Pharmaceuticals Inc. (NASDAQ: ACHN) – The timing on the Inhibitex deal couldn’t have been more perfect for yet another Hep C drug developer, Achillion Pharmaceuticals. Achillion also released positive data earlier this week, boosting awareness among investors— and catapulting the company to the top of many analysts’ lists of buyout contenders in this space. A market cap of just over $800 million makes this company the perfect size for a buyout.

Vertex Pharmaceuticals Inc. (NASDAQ: VRTX) – Although this mid-cap is outside the acquisition “sweet-spot” due to its market cap that tops $7.6 billion, the company potentially has a lot to offer a blue chip player who wants a more mature company with a more robust pipeline. In addition to its Hep C work, Vertex is also working on a promising late-stage cystic fibrosis drug. Vertex is also earning praise from analysts after cleaning up its balance sheet and beating earnings estimates for the previous three quarters.

Sincerely,

Greg Guenthner

3 Potential Pharma Buyout Targets was originally featured in the Penny Sleuth.