Looking for the Next Market Leaders

 | Sep 30, 2011 | 10:30 AM EDT
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Thursday's market session, with its gyrating action, was different from recent downdrafts. Even when the indices were higher, my growth screens didn't look so hot, with many bull market leaders of the past two-and-a-half years under intense pressure.

Weak price action in names like Priceline (PCLN), Green Mountain Coffee Roasters (GMCR) and Fossil (FOSL) raised yellow flags. Other bull market leaders, including Amazon (AAPL), Apple (AAPL), Ralph Lauren (RL) and Under Armour (UA), held above their 50-day moving averages but looked vulnerable.

It's a good reason to tread cautiously with new buys.

I've been favoring a heavy cash position in the model portfolio for several weeks. I held only three stocks going into Thursday, and I'm 100% in cash now. I'm waiting for new leadership to take shape. After all, there's a good chance that many of the aforementioned leaders won't lead the next leg up.

When new institutional money starts to move in from the sidelines -- I expect that to happen before the end of the year -- stocks attracting the biggest volume will have the best chance to lead. Focus on stocks being accumulated by the big guns, whether in tech, retail, health care or other sectors. Just be open to the fact that new leadership probably won't come from the usual places. Many have damaged charts that will take time to repair.

While stocks were bleeding badly Thursday, several health care names outperformed. One that I'm watching is molecular diagnostics firm Cepheid (CPHD). Last week, Goldman Sachs upgraded the shares to "Buy" from "Neutral." Yes, it sells at a sky-high multiple at 113x trailing earnings and 83x forward earnings, but sellers haven't been around this stock while several growth names have been hit hard.

Source: StockCharts.com

Source: StockCharts.com

Headed into Friday, Cepheid was only about 2% from a 52-week high. Shares did well Thursday, rising 4.2% to $40.10. When the company reports earnings Oct. 19, it's expected to earn $0.02 per share, reversing a year-ago loss of $0.02. Sales should rise 22% to $68.2 million. It's only expected to earn $0.10 per share in 2011, but analysts forecast that number to surge 370% to $0.47 per share in 2012.

Another stock that has my eye (which I highlighted earlier this week) is Nuance Communications (NUAN), which provides voice control and text-to-speech solutions for mobile phones, tablets, GPS devices and other consumer electronics. It also caters to the health care industry, offering dictation and transcription services that automate the input of medical information.

Shares outperformed Thursday, rising 3.2% to $21.04. I really like recent signs of accumulation (above-average volume price gains) in this name because it could eventually set the stage for a base breakout.

Source: StockCharts.com

Source: StockCharts.com

Nuance is well positioned for growth. It's not a fast grower, but it's a steady grower. Fundamentals are strong, growth prospects are solid, sales growth has been accelerating in recent quarters, and valuation is compelling at 16x trailing earnings and 13x forward earnings. The company recently reported a 17% rise in quarterly profit, with sales up 20% to $328.9 million. It has a market capitalization of $6.4 billion.

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