Weekly hotline Update #14 - 02-20-07

Over the past week the market popped higher and several of our Model Portfolio stocks reported good news. Four of our eleven positions, AVCI, MIG, ICLR, and GRMN, reported healthy earnings last week and their stock's reacted positively. That gave our portfolio a healthy boost. However, with the market unable to sustain more than two days of measurable price movement, the environment continues evolving into a stock pickers market. And when it comes to picking stocks, sticking with the best tends to product solid results.

This morning I saw a segment on CNBC with a guy touting index funds. There is a lot to be said for index funds as the simple fact is a lot of funds fail to consistently beat the S&P 500. Actually, this is a statistical trick. The good funds often under-perform for a year or to and then significantly outperform for a year or two. Another key is the date from which measurements are taken. However, when you look at thousands of mutual funds in concert, you are essentially looking "at the market." And it is hard for "the market" to beat the market as measured by the S&P 500.

So why not just settle for average and go with an index fund? Simple, I want better than average, and I know using a good selection process enables one to do a lot better than average. So, after three and a half months, how is the PRS Report doing? 64 stocks have reached our entry criteria with valid entry price. (5 new positions from Friday the 16^th do not have official entry prices until Tuesday's close.) Of the 64 eleven have already been closed. Because we are quick to close weak positions and let the strong ones run, all eleven were closed for loses. That leaves 53 open actives since our inception date on November 1, 2006.

Of the 53 open actives positions, 35 have advanced leaving only 18 with a loss. And, five of the 18 are down less than 1%. We cut the weak and let the strong run and that brings me back to the comparison I saw this morning. The chart above shows the performance of the PRS Open Active positions vs. the S&P 500. (The PRS performance line is based on average daily change of open active positions.) Even with the eleven stocks already closed, several of which were clearly "I'll pass" type situations, the PRS system is doing better than the S&P 500.

Note: the first two weeks of November were omitted because there were very few stocks whose performance skews the overall perspective.

While every stock doesn't go up and every day is not an up day, over time the best stocks tend to consistently shine the brightest.

The Market & PRS Time Plane:

The S&P 500 pushed to a new high while the performance of the PRS_3-90 line worked to a little lower level, so the divergence continues. If you read Tactical Trading Outlook, you know I have been talking about the historical similarity of the current market action. While the action of the past four months is quite self similar, the rise into the May 06 high shares many similarities to the current advance. In short, go with the historical pattern until it doesn't work any more.

The message is two fold. If something dramatic happens, such as a significant move above the top channel line or a break below the lower channel line, then we need to really take notice. Until then, the indices continue to meander higher within the context of a strong economic backdrop.

The main concern resolves around a break of the lower trend line, especially when considered relative to the similarity of the action almost one year ago. When the uptrend finally gave way almost one year ago the subsequent action was extremely damaging, especially to the sort of really strong stocks we are focused on. The good news is that sell off set up one of the best buying points in nearly two years. The next sell off will set up an equally attractive buying point.

I lines on the chart below illustrate the points I am discussing. If and or when we see a measurable breakdown, we will want to take action quickly to raise cash, and we already have a healthy level of cash in our model portfolio. The catch is the breakdown may not take place for several weeks or even possibly months. However, if time relationships remain similar weeks seems more appropriate than Months.

New Stocks

With a lack of significant market movement, the level of turnover remains low. However, on Friday with the Dow locked in one of its narrowest ranges of the past ten years, five stocks reached our entry criteria.

CAPA (Captaris Inc) reported earnings and the stock dropped. This resulted in its PRS_3 falling and it entered our entry criteria. This is on of those situations where it is worth taking note of the news driving the stock. For now this is an "I'll pass" stock. However, while their numbers were disappointing, they were not "bad." That means once the selling runs its course the stock may be able to recover. For now, take note of the stock but this is one to come back to at some point later on, possible in a few days or several weeks.

LHCG (L H C Group) is a great looking chart. The stock has been in a correction for a couple of months, held support at $25, and looks set to resume its advance. LHC Group provides post-acute healthcare services primarily to Medicare beneficiaries in rural markets in the southern US. With an IBD EPS ranking of 98 we know we are looking at a company with a strong earnings track record. IBES earnings estimates: 2005a $0.83; 2006e $1.09; 2007e $1.34; 2008e $1.60.

LHCG has turned the corner from down to up and is ready to continue its push higher through resistance at the $29 level. We are adding LHCG to the aggressive Portfolio today.

TWGP (Tower Group) took a nasty turn lower in January causing it to be removed from the Open active table. It quickly snapped back, which is often the case for really strong stocks. Now we are seeing another opportunity to enter TWGP. The stock is consolidating $34 and $35 on contracting volume. The stock looks positioned to jump higher. We are adding TWGP to the Aggressive Portfolio today.

TWGP (Tower Group Inc,) is essentially an insurance company providing a broad range of property and casualty, and other services to small and mid-sized businesses. TWGP priced a secondary at 31.25 on January 22. IBES earnings are huge: 2005a $1.03; 2006e $1.59; 2007e $2.44; 2008e $3.00. Look for TWGP to continue its push higher.

RBN (Robbins & Myers Inc) designs, manufactures, and markets highly-engineered, application-critical equipment and systems for the energy, industrial, chemical and pharmaceutical markets worldwide. IBD EPS rank is a solid 77. IBES earnings: 2006a $1.23; 2007e $2.30; 2008e $2.60.

RBN has been correcting since the end of December. It has established a support level around $40 and we are looking for RBN to hold $40. Ideally the best buy point is when RBN moves above the blue trend line, often referred to as the most obvious down trend line. 

Other issues that look attractive now: STEC (Simple Technology Inc.) going above $9.25; ICOC (ICO Inc) recovering well; CBEY (Cebeyond inc.) going above $31.75; MTW (Manitowoc Co Inc) is experiencing a nice recovery after a 2 month correction, healthy above $60; CBG (Cb Richard Ellis Group Inc) looks solid having pulled back from its high; LVLT (Level 3 Communications) continues to look very attractive; GRMN (Garmin Limited) looks great after an upside earnings related Jump; MIG (Meadowbrook Insurance Group) continues looking attractive after a healthy earnings related jump higher.

Don't like INTN; CRVL needs more time; SHOO is likely to be removed from the Open Active table within a few weeks; ANDE, is not going down, but it isn't really going up either and is likely to fall off the Open Active Table within a few weeks; NITE will likely hold support but that won't be good enough for us, expected to drop within a few weeks.

Exits
 

Only 2 stocks reached our exit criteria. BLWD and MED. BLWD was only on  the list for two weeks and went through a volatile stretch going into their earnings report, which came out much better than expected. The stock managed to jump back quickly. In fact, its PRS_12 reading was below the key 75 level for only one day. MED is a pre-live exit.

Open Actives positions of Interest

There are a lot of green and red stocks in the Open Active table. With few exits and a number of new entries, the total number of stocks on the Open Active table jumped from 173 to 178.

We continue to maintain a very conservative posture in our portfolio as we hold close to 30% cash.

• We are making no changes to our conservative portfolio.

Our second portfolio is a more aggressive portfolio, which will hold 35 to 45 positions and is based on a $500,000 initial account size. Ideally this portfolio will reach maximum exposure as the market reaches some sort of 2007 low over the next few months.

Last week we added 1000 ACGY @ 19.86

Add 600 TWGP @ 34.26
            Add 700 LHCG @ 27.78

The market continues to follow what has become a highly predictable pattern. With a strong economic background the only thing to fear should be fear its self. However, market cycles are what they are and while they can extend for remarkably long periods of time, they eventually make their presence known. The most concerning feature at present is the action of the PRS_3-90 line, which continues to diverge negatively. For now the environment remains positive yet it is clearly growing more difficult as we move further into 2007.

Chinese Fortune Cookie (I don't get good ones very often)

Life consists not in holding good cards
but in playing those you hold well.

Jim Patterson