Surveying the Damage

 | Apr 11, 2012 | 10:35 AM EDT  | Comments
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I've been trying to keep an open mind about this market for several days now. That's despite the fact that yellow flags have been out there for a while, namely in the form of multiple higher-volume declines in the major averages since the middle of March.

But Tuesday's market decline was different from others before it. Major averages got hit with the most significant day of institutional selling we've seen since the start of the uptrend in December. The difference this time was that technical damage was widespread, with several market-leading growth stock taking hits in heavy volume. Price action like this is often seen ahead of a consolidation phase for the market.

The message I got from Tuesday's downdraft is that the selling will most likely need more time to run its course. Growth stocks can't run up forever, and I believe many high-quality names are in the early stages of consolidating recent gains and forming new bases. A good base -- in which a stock digests recent gains -- generally takes at least five weeks to form. The worst thing that could happen to this market would be for it to digest gains for only one week and then start heading higher again. But I don't see this happening.

On Tuesday the S&P 500 dove 1.7% to 1358 and took out its 50-day simple moving average at 1372. Like the other major averages, it made no effort to rally whatsoever. Volume on the NYSE rose to around 900 million shares, well above Monday's level of just over 700 million. It was the heaviest volume on a S&P 500 down day since Feb. 29.

The Nasdaq Composite, meanwhile, held above its 50-day simple moving average Tuesday, but not by much. The tech-heavy index closed at 2991, down 1.8% and just above support at 2988. Volume on the Nasdaq came in at just over 1.9 billion shares, well above Monday's level of nearly 1.3 billion.

Market bulls can still hang their hat on the fact that the Nasdaq 100 is still holding above its 50-day simple moving average at 2643. The index closed Tuesday at 2695, down 1.6%. Sellers finally came into Nasdaq 100 component Priceline (PCLN), which lost 3.1% to $741.26 in heavy volume. It's still holding above key support levels, but another Nasdaq 100 firm wasn't so lucky. Former market leader Fastenal (FAST) plunged below its 50-day moving average, falling 5.2% in huge volume ahead of its scheduled earnings report on Thursday.

Other market leaders, such as United Rentals (URI), Transdigm Group (TDG), W.R. Grace (GRA) and Solarwinds (SWI), gave up their 50-day lines in fast turnover Tuesday.

I started taking profits in my Ultimate Growth Stocks model portfolio last week. On Tuesday, I closed my position in Trimble Navigation (TRMB) at breakeven because of its weak price action. I also took profits recently in Salesforce (CRM), BE Aerospace (BEAV) and Buffalo Wild Wings (BWLD). I don't regret the decision, because growth names such as these are vulnerable in a market that's under distribution, and that's the situation we're seeing now.

Managing risk-reward levels is a key part of my investing strategy. It has to be, because I generally target fast-moving stocks -- names that can outperform materially in up markets and underperform materially in down markets.

The market risk currently outweighs the reward, so it wasn't a hard decision to start moving to cash. I am still long some names, but my portfolio is only about 30% invested at this point, which is fine. I'm perfectly content to sit out the selling. I still own some names whose uptrends remain intact. If the market starts heading higher sooner than I expect, I can add to these names where I see fit.

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