Losing the Leaders

	Elliott Gue PF Newsletter.com
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The market hasn't been taking this summer's economic data very well. Retail sales, inflation and economic growth numbers have all surprised the Street to the downside.

Most important was a weak jobs report in early August. In the wake of that report, the US Treasury market spiked higher, suggesting the market is pricing in a less-aggressive Fed tightening cycle. The implication of that action is that the recovery isn't as hot as many had expected back in the spring.

This may well be nothing more than a temporary slowdown. It's not completely uncommon to see recoveries stall out for a few months and then reaccelerate.

But in the short-run, the data is putting downside pressure on the major averages--July was the worst month for the market since 2002.

What's even more significant is the loss of key leadership groups despite positive, strong earnings reports. Several large semiconductor companies, for example, came out with solid reports in July only to sell off on the news. A similar pattern repeated for some well-known biotech and Internet names.

Note, in particular, the 20-point (36 percent) one-month fall in e-tailer Amazon.com and the 15-point (31 percent) one-month fall in semiconductor-maker Broadcom in the wake of these companies' second-quarter reports. Such rapid selling at the first whiff of bad news isn't the type of action we like to see out of the rally's leaders.

The Advantage Portfolio is currently in a neutral position with two long recommendations and two shorts. But with the market heading into what's traditionally been the worst month of the year for stocks, it's time to beef up our exposure to the short side. In this issue, we'll add two short recommendations and one long to the portfolio.

The Long

In the almost uniformly negative month of July, it was difficult to find companies that reacted well to their earnings releases. One notable exception was Textron. The company is a conglomerate with operations in auto and airplane parts, defense and finance.

Textron's Bell Helicopter division makes helicopters for the military, some in concert with Boeing. In addition, the Textron Systems unit makes so-called "smart" weapons and various surveillance systems. Over the last few years, rising defense orders have gradually boosted margins in both segments and boosted the defense share of the company's overall revenue pie.

Cessna is a recovery story. The economic slump hurt sales of the company's business aircraft over the past few years. But management has been cutting costs to keep the losses to a minimum.

Now that the aircraft market has recovered somewhat, profit margins are surprisingly to the upside. Buy Textron under 65 with a stop at 57.45.

The Shorts

On the short side, Davita looks to have a downside to $20 or so. The company operates dialysis centers for hospitals around the country. That's a fairly solid and growing business, yet is dependant on reimbursements from the Medicare system.

The problem is that new proposals for Medicare might change the way companies are paid for anemia--low red blood cell counts--treatments. Because anemia is a fairly common side effect of dialysis treatment, this is a problem for this group.

It's notable that Davita lowered guidance for next year precisely because of this Medicare issue. Short the stock above 25 with a stop at 31.75.

Our second short recommendation is Amazon.com. This company is a classic cracked momentum name. The stock moved over $50 this summer ahead of its second-quarter release, but investors were way too optimistic on the business prospects for the latter part of this year.

When Amazon issued tepid guidance, the stock sold off rapidly. We still believe there's more downside.

Short the stock over 35 with a stop at 43.50. Note that out initial stop is very loose--we'll be revising that stop in an upcoming issue to better control risk.

Elliott Gue will be available to take your questions until Monday, September 20. Please use the form below to submit your questions.