With all the green on my screen and the strong scent of bullishness wafting through the air, I’ve decided it’s only prudent to cut my losses and cover all my short positions in the Channeling Stocks Portfolio. Is this wise or is this rash?

That’s the $64,000 question everyone seems to be asking. To answer it, let’s look at some technicals.

On the plus side
The VIX (volatility index) has been in a steady down-trend since the middle of January (see chart below). The Dow Transports, widely regarded as being a leading market indicator, has managed to stay above the 300 key resistance level. Financials and banks, given by the XLF and the RKH, have both broken out of their inverse head and shoulders pattern. They haven’t exactly zoomed out of the gate, however, and may continue in a sideways pattern for a while until the economy finds its legs. Heck, even some of the homebuilders have broken above their channeling patterns. Take a look at the charts of Meritage (MTH) and KB Homes (KBH) and see for yourself. (The chart of MTH is shown below.)

And contrary to popular belief, the consumer is not completely dead. Consumer Discretionary (XLY) has been following the Retail Holder (RTH), climbing steadily since their March lows (although they do appear to be running out of steam). Because of the threat of the swine flu and recent mergers, the biotech sector has been on fire but that, too, looks like it’s poised for a breather. Tech, too, has been rallying. The Broadband Holders (BDH) and the Internet Holders (HHH) are up 25% and 33% respectively since the beginning of March. Really, the only sectors that have been underperforming are the precious metals– both gold (GLD) and silver (SLV) are down roughly 10% over the last several months.

A couple of negatives
One negative is that the S&P 500 is having a problem closing above 875, a key resistance level. It’s traded above that on an intraday basis and I think it’s only a matter of days before it closes above it. The real question is: Is this rally for real or is it the response to massive short-covering?

The answer is that I don’t know for sure–perhaps it’s a bit of both. One non-technical indication that a recovery is in the works is that the number of For Rent signs in my neighborhood seems to be decreasing. Hey, it’s not exactly the lipstick indicator, but I think there is something to it.

Click on images to enlarge.

Many apologies for shirking my blog duties lately. I’ve been immersed in several business projects which are taking 110% of my time, but that doesn’t mean that I’m dropping my beloved blog altogether; rather, my posts will be limited in scope for the next month or so—at least until after the LA Trader’s Expo where I’m scheduled to give a workshop on June 4th. More on that as the date approaches.

Today I wanted to provide a list of quick trades that the more risk tolerant may want to consider as a play on the swine flu outbreak. Don’t get me wrong, I’m not trying to make light of this subject at all and I grieve for those hundred plus people who have already succumbed to it. Let’s hope and pray that this outbreak can be contained and it doesn’t turn into a pandemic health crisis. Since we’ve been given another bowl of lemons, we could at least try to make some lemonade from it, no?

Below is a table of the major players involved in the development and manufacturing of flu-related vaccines, treatments, and tests. The major players are Gilead (GILD) and Roche (trades here as an uninspired ADR) who teamed up to make Tamiflu, and GlaxoSmithKline (GSK—also an ADR) which makes Relenza, an inhaler-based flu treatment. All of these stocks traded on the plus side but they weren’t even close to being the biggest winners—their smaller compatriots stole that show.

Topping the small-cap flu-related biotechs today were Novavax (NVAX) and BioCryst (BCRX). Both of them increased at least three-quarters in value and traded at astronomically high volumes. Both stocks gapped up on the open. From there, they meandered steadily downward closing the day near their lows. Novavax took out both its $1.75 and $3.00 resistance levels ending the day at $2.54. It’s next major resistance is at $4.00 (for a gain of 57% if it hits it).

BioCryst closed at $3.88. Next point of major resistance is at $5, or almost 30% above today’s close. Both of these stocks are short term plays (up to resistance) unless the swine flu crops up in more places. Let’s keep our fingers crossed that it doesn’t. Here are the weekly charts of the above two companies with resistance levels:

These plays are not for the faint of heart, but if you have a little extra mad money, you could do worse. The good thing is that they’re cheap compared with their big-pharma brothers. The bad thing is that I’m getting rather tired of drinking lemonade.

For further info on how these companies are positioned in terms of the swine flu, begin with this article that appeared today in the Associated Press.

Updates to Channeling Stocks Portfolio
Friday’s bullish action triggered stop-losses on five short positions in the Channeling Stocks Portfolio: DHR, RBC, ROP, SOHU, and UPL. Both the Channeling Stocks and the MANDA weekly tables will be updated later this evening.

Just sticking my head in to say that the BLK and TOT short positions were covered in the Channeling Stocks portfolio. TOT almost reached its $45 target several days ago, and today’s up movement looked like the $45.02 low put in then was probably the channel low. The nebulous part about playing channeling stocks is that sometimes the target value is never quite reached, and I believe that if the stock starts to move in the opposite direction, it’s best to get out of your position.

At least I made a profit on this one. Yay me.

Yesterday I mentioned that people are starting to bottom fish for companies with low debt on the assumption that they’ll be the fastest to rebound once the economy starts to recover. But there is contradictory evidence that it’s precisely the debt-laden companies that are seeing the biggest rise in stock price. Today I’d like to delve further into this conundrum and see if we can find some clarity.

The fundamental argument
In an article that appeared on MSN Money yesterday, Jim Jubak said that if you want to do some stock shopping, avoid companies that have loaded up on debt such as restaurant chain owners DineEquity (DIN) which sports a hefty debt/equity ratio of 10.22 and Brinker International (EAT) whose debt/equity ratio is a more modest 1.44. (A debt/equity ratio greater than 1 signals that the company is running more on debt than on equity. Stocks with high debt/equity ratios are considered riskier than those companies with little to no debt especially in rising interest rate environments.)

I like Jim’s articles. He does his research and knows his stuff, but apparently he forgot to check the charts. Since the market low on March 9th, EAT has doubled in price while DIN has quadrupled–good thing we didn’t buy those stocks!

The technical analysis
A recent CNBC guest commentator said that it was precisely these debt-laden companies that have been the best performers in recent months. Not to doubt the gentleman’s veracity, I decided to find out for myself. What I did was to screen for the highest percentage gainers in the past month that were over $2 and traded at least 100,000 shares per day on average. (I used the deluxe screener in MSN Money–it’s free!) Out of the 100 stocks that came up, seven of them had no debt/equity listing so I discarded them leaving me with a sample space of 93.

Of those 93, 53 companies had debt/equity ratios greater than one, or 57% of the total. That’s not much more than average but it is a lot more than I would have expected especially in this credit environment. And of the 26 companies that had gained more than 100% in value, 15 had debt/equity ratios greater than one, or 58%.

Today’s percentage gainer list was even more interesting. The top two stocks were Avis/Budget (CAR), up 22%, and Reddy Ice Holdings (FRZ), up 18%. Are they low-debt companies? Hardly. The ratio of debt to equity for Avis is 84.11 which is high even by industry standards (6.18 on average). Even more incredible is that the same ratio for Reddy Ice is an astronomical 450.76, the highest of ALL stocks over $2. I mean, all they do is sell packaged ice, for crying out loud. I don’t get it. I can only scratch my head as to why an ice company is topping the list—could this be a play on global warming?

Conclusion
The point to take away here is that it seems as if investors are ignoring conventional wisdom and valuing other aspects of the business besides some numbers on a balance sheet, and to me, that’s what really makes sense. But if you want to bait your hook with the debt/equity ratio, I’d use the one that will snag the high-debt fish.

Here’s a chart showing how you would have done over the past month had you bought an equal dollar amount of the each of the top 25 debt-laden companies:

Did you see that there were only 5 losers?

Here’s the stock move Jim Jubak missed:

Channeling Stocks Update
Today BMI violated its stop and I covered the short position at the closing price. I won’t be taking any new positions in this portfolio as right now I don’t have the time to search for them. I’m very busy trying to get my website up and constructing my workshop for the LA Traders Expo on June 4th.

Rumors of the death of the bear market may be greatly exaggerated but that isn’t stopping anyone from bottom fishing. From CNBC’s Jim Cramer to MSN’s Jim Jubak, financial bobble heads are advising their flock to start buying and offering their thoughts on what to buy and what not to buy.

At the top of nearly everyones Do Not Buy List are companies that have loaded up on debt. You’d think that would be a no-brainer but according to a CNBC guest contributor that appeared on the network several days ago (Friday?), the stocks that have been performing the best have been exactly those unloved debt-laden companies while the worst performers have been those touted by analysts and other Wall Street pundits. (I was on the CNBC site and couldn’t locate the clip, alas.)

I know this logic sounds completely upside-down. It could be that the cash acquired from taking on debt is allowing companies to function during this time so that when the economy does start to recover, they’ll be well-positioned to take advantage of it.

I’d look into it if I had more time today,but I’m off to visit my programmer and work on my website. Maybe tomorrow…

I spoke with an old friend over the weekend who was crowing that he made enough money in the stock market recently to buy a sports car. “That’s nice,” I replied, not meaning it of course. I was about to change the subject but instead asked him how he did it. I was especially curious since he had said only a few months ago how he thought the market was completely manipulated and way too volatile and he vowed never to buy a stock again. Since then, he retired from his lucrative physician practice and is finding that he’s got way too much time on his hands so he decided to dabble in high beta stocks—quite a reversal from his previous position that the market was too risky!

What is beta?
The point of this article is not to write an academic treatise on beta but since I brought it up I feel it’s only right to explain it. A stock’s beta measures the amount that a stock moves relative to a benchmark, typically the S&P 500. So, if the S&P moves by -4% like it did today, a stock with a beta of 2.0 will typically move by -8% and a stock with a beta of 0.5 will only move by around -2%. Betas typically fall in the 0.5 to 4.0 range, and there is such a thing as a beta for upward movement and one for downward movements. They’re not necessarily the same but most data services only provide one number and I don’t know which one that is. (It could be an average of the two.)

To make a short story long, I reminded my friend that high beta stocks are great performers in bull markets but can quickly turn against you in a bear market, to which he replied, “But we are in a bull market!” Doctors in general have a tough time with contradiction and my friend is no exception so I stifled my opinion knowing that it would fall on deaf ears.

Anyway, the point of this piece is not for me to gloat that possibly his high beta stocks didn’t fare so well in today’s market nosedive and that he might be looking at buying a bicycle instead; rather, I’m mentioning it to emphasize two points. The first is don’t gloat about making a killing in the market before cashing in your chickens (to mix metaphors). This happened to two other acquaintances just before the dot com bubble burst. One of them crowed that his dot com call options quadrupled in price and the other said that his retirement account was up by $500,000. When I mentioned to both of them that it might be prudent to take some money off the table, they laughed. They both believed the Dow 50,000 theory that was circulating at the time and hung on to their positions.

You know where this is going. Those call options expired worthless when the company went bust and my other friend confided to me recently that he won’t be able to retire when he thought since the value of his IRA had fallen faster than Bernie Madoff’s credibility.

The second moral to this tale is that even if you do take some chips off the table, don’t gloat about how much you made with the “I’m such a genius” grin. Not only does it make you look like an inconsiderate jerk but things like that usually have a way of coming back to bite you.

That’s the part I get to enjoy.

MANDA & Channeling Stocks Update
In the financial world, Monday is called Merger Monday because that’s when M&A deals that were finalized over Saturday’s golf game are announced. Because of the credit crisis, Merger Monday is now just called Monday but today’s mega merger announcements may change that.

Sun Microsystems (JAVA) finally ended its mating dance with IBM and got in bed with Oracle (ORCL) instead. The deal makes sense for both companies as Oracle relies heavily on Sun technology and the companies’ CEOs are long-time bffs (best friends forever). The deal relies on the usual shareholder and regulatory approval, and although anti-trust issues can be raised, I do think it will ultimately be approved. The deal is for $9.50 in cash per JAVA share. I picked some up earlier this morning at $9.10 for the MANDA portfolio. This represents a 4.2% return on the trade.

The announcement that PepsiCo (PEP) is intending to buy two of its bottlers, Pepsi Bottling Group (PBG) and PepsiAmericas (PAS) caused both stocks to soar. That’s great news if you’re long either of them but bad news if you’re short like I was on PAS in the Channeling Stocks Portfolio. The stock was covered at today’s closing price for a 35% loss on the trade. Ugh ugh ugh. Oh, I’m not buying either PAS or PBG for MANDA because both deals involve stock swaps as well as cash, and I don’t like taking a stock swap unless I’m pretty sure of the final price of the company doing the acquiring.

No blog today but I did cover my DO short in the Channeling Stocks Portfolio. Below is the table of current and closed positions. In this market, a much better recipe to be playing is the Channel Breakout strategy. Once a stock breaks out of its channel, it has a strong tendency to continue moving in that direction. Here’s a list of non-ETF stocks that have recently broke out of their channels: AAPL, AMTD, BBW, CEC, DTV, FLS, KBH, LAZ, MCHP, MHP, NBL, NVDA, ORCL, PANL, PCAR, SEED, SPAR, ZRAN, and ZUMZ (Zumiez) which broke out today.

Click on table to enlarge.

My charting program was ringing its head off this morning (it has one of those really annoying “ay-ooh-ga” tones) in response to the many bullish alerts that I had set:

1. The VIX closed its gap set on 9/29/08.

2. The Dow Industrials closed above 8000. But more importantly…

3. The Dow Transports finally closed above 300, a major resistance level.

4. All of the major sectors were up today except for precious metals, oil & gas, and utilities.

5. Foreign ETFs had a good day, too, with BRIC countries at the head of the pack.

The only thing that concerns me is the lack of volume in many of these issues, especially the SPY, the S&P 500 tracking stock. Normal volume is in the 368 million share range; today only 86 million shares traded hands, about 23% of normal.

So what’s an investor to do? Well, I’d ready a buy list and start dipping my toe into the small-cap waters because that’s where my market indicator is generating a buy signal. And, when markets do recover, it’s the small stocks that lead generally lead the parade. Although precious metals have been sliding, their poor relatives, the base metals, have been forming a saucer bottom. The chart of DBB, the Powershares Base Metals tracking stock, recently broke out of its saucer base. (The BDG is very similar except that it is an ETN (exchange traded note) and is much more thinly traded.) Note the huge increase in recent volume.

Channeling Stocks Update
Today I exited four short positions at the closing price: DTV, MHP, PANL, and PCAR. No new positions were initiated.