Finding an Edge When the Market Moves Higher
It is becoming more and more difficult for me to deny the rally we are now witnessing. The market is melting up right before our very eyes. Bears will try to explain away the 5%-plus move in the S&P so far this year as a fluke or a temporary reaction to oversold conditions. But there are simply too many forces at work right now that are encouraging the market to seek higher ground…
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…
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