S&P 500 Dow Jones Industrial Average

TUESDAY, OCTOBER 5, 2010

General Market Overview: Market Is Sending Mixed Messages

Headed into this week, recent price and volume trends in leading stocks were a bit ominous, leading me to believe that a long-awaited pullback might be upon the market. It's still too early to turn outright bearish, though, especially in light of Tuesday's strong gains. Still, the market's message from recent sessions suggests that stocks could be ready to take a breather.

More selling hit leading tech names Monday, a continuation of the weak price action we saw late last week. The Nasdaq underperformed on Monday, falling 1.1% on the day, but the good news was that volume fell slightly from Friday's level. While Monday's session had the feel of institutional selling, the silver lining was that it wasn't confirmed by a huge increase in trading volume.

After strong gains for the market in September, the question on investors' minds now is whether or not the market can continue to rally in October. I noted in last week's Weekly Update that I wouldn't be surprised to see the Nasdaq pay a visit to its 200day moving average at 2286. If this scenario plays out, I would expect to see some support at this level. If not, the next stop would be the 50-day moving average at 2258.

Don't give up hope yet, though. The market precedent gives us reasons to be optimistic about October. My friend Paul Whitfield at Investor's Business Daily offered up this little tidbit over the weekend: "Seven of the past nine Octobers in midterm years have been winners for stocks. The average gain in the Nasdaq was 8%."

That's good news for the bulls, but the bears have ammunition, as well, given the market's performance on Sept. 30. On that the day, the S&P 500 flashed a bearish "outside reversal day." (An outside day occurs when an index's intraday high and low exceed those of the prior day.) This is exactly what happened on Sept. 30, not only for the S&P 500 but for the Dow Jones Industrial Average and Nasdaq, as well. An erratic day of trading like this in heavy volume (after a lengthy run-up) can often flag a change in trend.

Upcoming Economic Data

It's a fairly light week for economic data releases, but investors will get another look at the weekly jobless claims on Thursday. Claims have bounced around lately, but last week they fell more than expected to 453,000. This week, they're expected to rise slightly to 455,000. On Friday, nonfarm payrolls are expected to be flat with the unemployment rate and tick higher to 9.7%. Nonfarm private payrolls are anticipated to rise 70,000 after a gain of 67,000 in August.

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Model Portfolio Update

The model portfolio currently holds 22 stocks. In recent days, I've trimmed winning positions, which has increased my cash position to about 35%. That's a bit high, so I'll look for opportunities to put money to work, but I don't want to be too aggressive with new initiations at a time when the market could be on the cusp of pullback. That said, I added a position in Coach (COH) yesterday and another in Checkpoint Software Technologies (CHKP) this morning. See the individual company summaries below for more details on each stock.

As a reminder, to stay consistent with other model portfolio managers at The Street, I am now using a number system to rate the current holdings in my model portfolio. Positions designated as Ones (1) are stocks that aren't extended and are still within buying range while Twos (2) are stocks I have on hold.

Last week, I lowered my ratings on two holdings: Cyberonics (CYBX) and Altisource Portfolio Solutions (ASPS). My decision to lower each from a One to a Two isn't because I'm bearish on each stock. It simply means that both stocks have moved too far past their proper buying points and are currently extended in price. I generally consider a stock extended when it moves 4% to 5% past a buy point. The last proper entry point for Cyberonics was when it broke out over $24.98 (its Aug. 3 intraday high). Some pretty serious selling hit Cyberonics on Monday, so I sold half of my 400share position. Cyberonics shares closed Monday at $25.54, down 7.8% on the day. Meanwhile, the last buy point for Altisource was around $28.80 (its Aug. 10 intraday high). Altisource shares closed Monday at $29.57, down 3.5% on the day.

I also cut ties with two high-beta names last week: Green Mountain Coffee Roasters (GMCR) and OpenTable (OPEN). Shares of Green Mountain got slammed on Sept. 28, gapping down 16% on news of a Securities and Exchange Commission (SEC) probe into revenue recognition practices. When an aggressive growth names is hit with an SEC investigation, it rarely turns out well, so I decided to sell my stake for a small profit.

Meanwhile, OpenTable is another super-charged stock that looks as though it is ready to take a breather. I did well with my first go-round with the stock when I bought it at $42.04 on June 15 and sold it at $51.91 on Aug. 17. I re-entered the name at $68.02 on Sept. 23, then sold my holding at $69.18 on Sept. 29. At the time I thought OpenTable would be able be to break out successfully over $67.33 and I would book a quick gain of 8% to 10%. However, the heavy volume and limited price progress that occurred soon after I bought it indicated that the stock was churning and possibly ready for a downturn. I believe the risk outweighed the reward at its then-current levels.

On Monday, I closed my position in Eldorado Gold (EGO) for a small profit. Its recent breakout attempt over $19.87 didn't go anywhere and the recent above-average volume declines point to institutional selling.

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Here's a look at the current weighting of the portfolio as of early Tuesday.

Current Holding (2) Apple (AAPL) (2) Lubrizol (LZ) (1) Cognizant Technology Solutions (CTSH) (2) Altisource Portfolio Solutions (ASPS) (1) Panera Bread (PNRA) (1) Tenneco (TEN) (1) Coach (COH) (2) Trina Solar (TSL) (2) DirecTV (DTV) (2) VMware (VMW) (1) Oracle (ORCL) (1) The Andersons (ANDE) (1) Checkpoint Software Technologies (CHKP) (2) Toll Brothers (TOL) (2) NetApp (NTAP) (2) Medicis Pharmaceuticals (MRX) (1) Stericycle (SRCL) (1) HMS Holdings (HMSY) (2) Cyberonics (CYBX) (2) Baidu (BIDU) (2) Banco Santander-Chile (SAN) (2) Wynn Resorts (WYNN)

Allocation 4.3% 4.1% 3.8% 3.5% 3.4% 3.3% 3.3% 3.3% 3.2% 3.2% 3.1% 2.9% 2.9% 2.9% 2.9% 2.8% 2.7% 2.3% 2.0% 1.9% 1.9% 1.8%

% Gain/Loss 7.1% 10.3% 20.9% 8.0% 3.9% 5.6% 0.05% 11.9% 16.9% 16.3% -1.0% -4.4% 0.0% 9.1% 28.9% 6.4% 7.0% 13.0% 15.5% 9.9% 36.5% -4.0%

ONES

Oracle: I initiated a position in this tech name on Monday based on its strong fundamental and technical picture. Shares jumped 8% on Sept. 17, after the company reported blowout, fiscal first-quarter earnings. Profit jumped 40% from a year ago to $0.42 a share, while sales grew 48% to $7.5 billion. The results marked the third straight quarter in which the rate of sales growth has picked up, and acceleration like this is good to see. From a technical perspective, I like that Oracle been able to hold on to virtually all of its gains since its strong move on Sept. 17. Tight, sideways trading after a breakout is a sign of strength and support. Oracle's software business remains strong, but management is also counting on hardware to drive growth going forward, thanks to its January acquisition of Sun Microsystems. Shares closed Monday at $26.90, down 1.1% on the day.

Coach: I added this luxury handbag maker to my holdings on Monday based on its solid fundamental and technical picture -- despite the recent weakness in the major stock indices. I believe an upside breakout could be looming if the recent market uptrend continues into the end of the year. China continues to be the strongest growth opportunity for Coach, and the company is focusing on the Chinese middle class by opening stores in smaller cities. In early August, Coach reported a 49% increase in its fiscal fourth-quarter earnings of $0.64 a share, while sales growth accelerated sequentially for the third straight quarter, rising 22% from the year-ago period to $950.5 million. Shares closed Monday at $42.90, down 0.5% on the day.

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Cognizant Technology Solutions: This large-cap provider of consulting, technology and business process outsourcing services continues to look good after its recent breakout over $63.94. Cognizant announced a partnership with Microsoft (MSFT) to deliver cloud-enabled solutions to enterprise customers. Shares closed Monday at $64.65, down 1.8% on the day.

Panera Bread: Last month, a Raymond James analyst released positive comments about the restaurant chain and raised his price target on the stock to $105 from $95. Panera is a very well-run company and has charted a consistent track record of bottom-line and top-line growth in recent quarters. The stock recently broke out over $85.13. Shares closed Monday at $88.44, up 0.1% on the day.

Tenneco: The recession took its toll on this emissions- and ride-control systems manufacturer for the automotive industry, but the company could be in the middle of a nice turnaround, if recent earnings and sales growth are any indication. On Sept. 29, Tenneco staged a nice breakout over $29.74, but it showed strange price action the next day when shares dropped 4.4% in above average volume. This isn't desirable price and volume action one day after a breakout, but I'm still confident about the stock's potential to outperform. Shares closed Monday at $28.77, down 1.8% on the day.

The Andersons: The stock tried to break out over $39.20 recently, but it has had trouble making headway. The Environmental Protection Agency (EPA) is expected to rule soon about increasing the ethanol percentage used in gasoline. If approved, this should spur ethanol demand. The stock closed Monday at $37.79, down 2.2% on the day.

Checkpoint Software Technologies: I initiated a position in the security-software firm earlier today because the stock was still within buying range after it recently achieved a solid upside breakout over $36.21. Its fundamentals and technicals continue to look good and I am expecting strong earnings when the company reports its third-quarter results, which are scheduled for Oct. 20. Shares were recently trading around $37.24.

Stericycle: The provider of waste management and related services to hospitals and pharmaceutical companies continues to show relative price strength after recently breaking out over $67.47. Last week, the company announced a small acquisition. It will buy privately held Healthcare Waste Solutions for $245 million in cash. Shares closed Monday at $69.75, down 1.4% on the day.

HMS Holdings: The company provides cost-containment, revenue recovery and benefits coordination services to government health care programs, including Medicaid and Medicare. This is another holding with a consistent track record of growth, and I believe it is well positioned for continued growth. HMS Holdings recently broke out over $56.97. Shares closed Monday at $59.56, up 0.4% on the day.

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TWOS

Trina Solar: This China-based solar name is prone to volatile price swings. Last week, shares broke out nicely over $28.87 in above average volume. Also last week, a Jefferies analyst put out a bullish note on the solar sector, basically saying module prices for 2011 are running significantly ahead of consensus expectations. I'm maintaining my Two rating in this name because of its weak price action on Monday. I don't like seeing price action like this so soon after a breakout. Shares closed Monday at $27.92, down 5.2% on the day.

Apple: Some heavy-volume selling hit the stock last week, but it continues to show resilience. Early last week, a rumor surfaced that Apple's chief operating officer, Tim Cook, was on his way to Hewlett-Packard (HPQ), but the rumor was quickly shot down. Apple shares recently broke out above $265.99. I will look for another opportunity to add shares, but it will depend on the future price and volume action in the stock. If the broad market decides to pull back a bit, the stock could pay a visit to its 50-day moving average around $266. This could be a good area to add. Of course, the market rally could continue in October. If it does and Apple heads higher, I will most likely sit tight in the position because it's currently the largest weighting in the model portfolio at 4.3%. Shares closed Monday at $278.64, down 1.4% on the day, and about 4.8% below its last buying level around $265.99.

Lubrizol: Strong stocks tend to shake off downgrades, and that's what happened recently in this specialty chemical company. Lubrizol continues to trade well, despite a recent downgrade by Hilliard Lyons to neutral from long-term buy. The stock recently broke out over $96.74 and continues to show strength and resilience -- exactly what you want to see after a breakout. Shares closed Monday at $105.92, down 0.4% on the day, and about 9.5% past its last buying vicinity around $96.74.

Baidu: Headed into this week, the China-based search firm showed three aboveaverage volume declines in the past four trading sessions. Last week, I took partial profits by selling 50 shares of my 100-share position. Recent price and volume action in Baidu suggests the stock wants to pull back some. Shares closed Monday at $96.22, down 2.6% on the day, and about 8.9% past its last buying area around $88.32.

Cyberonics: I trimmed my position in this health care name on Monday, due to its heavy-volume decline. The company's Vagus Nerve Stimulation (VNS) therapy system is currently used to treat epilepsy and depression and it also has potential to treat other neurological disorders, including Alzheimer's disease, anxiety, chronic migraine headaches and bulimia. Despite Monday's decline, the stock is still holding above its 20-day moving average just under $25 and its 50-day moving average just under $24.

Altisource Portfolio Solutions: This real-estate services firm recently broke out over $28.80 and it is showing good price action post-breakout. It's a fast-growing firm that still seems undervalued to me. Currently, it sells at 20x trailing earnings and 15x forward earnings.

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