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Word association

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It's that time of year again! No, not tax-time, but quarterly reporting time for mutual funds. Actually, there's about one month left before most mutual funds create their quarterly reports to show investors what a great job they've been doing with everyone's hard-earned investment dollar.

Pretend you're the mutual fund manager and you're getting ready to make some adjustments in the coming weeks before the quarter ends in March. At the end of the March you're going to also go before your board and outline your investment strategy and discuss you top 10 holdings.

Today you've got some cash that you need to put to work. So far, you've gotten two calls from your research team that two stocks are breaking out technically and giving some powerful supply/demand breakouts to new relative highs.

You're interest is peaked, you wouldn't mind adding a stock to the portfolio that is breaking to new highs.

The first technical analyst says... "this is a software related stocks that that develops and distributes interactive entertainment and leisure products. The stock just triggered a triple-top buy signal at $29 yesterday and trades with a P/E 40. The software group is a little weak right now, but nearing a lower level of risk and this stock looks to be a leader. The sector bullish percent is currently bull correction at 32%."

On the other line analyst #2 says... "this one isn't going to sound exciting, but its an office supply retailer that has broken another triple-top at $19.50 today. I called you on this one at the last triple-top of $16.50 and you passed and I want to get you involved here at $19.50. The stock trades at a lofty P/E of 148. The business products group has been strong and the sector is bull confirmed at 64% bullish.

As it relates to "word association" what are your initial thoughts? Think about the MARKET and the SECTOR data. Also consider the price/earnings multiples.

Now you're making some notes and while you have an initial bias (positives and negatives) the stocks are giving bullish upside entry alerts. Do you take equal dollar positions in both?

Have you made a decision yet? You better not have. What are the price projections? We can't make any decision without knowing what type of potential upside exists can we?

Activision Chart - $0.50 and $1 box

Shares of Activision (NASDAQ:ATVI) $28.98 -0.24% have been trading strong relative to the sector. On first glance we note the stock has come close to achieving a prior bullish vertical count of $30.50. Fund manager may be thinking "tech is out of favor right now, but technicals are compelling, will take just 1/2 position as bullish here as stock is close to first vertical count and sector still bearish. Looks to be a leader in the group and will add to position once sector internals improve to a more bullish phase." Current risk reward is 20% risk, and 37.9% reward (based off stop $23, target $40 which could grow with X).

Staples, Inc. Chart - $0.50 and $1 box

Shares of Staples (NASDAQ:SPLS) $19.83 +2.79% have been trading strong relative to the market and mimicking the sector bullishness. The initial bullish vertical count from the apparent bottom indicates bullishness to $29.50 and that price has yet to be tested. The recent decline to $16.50 starting to look like a bear trap as reversal was quick and came at support of $16.50. Current bullish vertical count is to $26, but could grow should stock put in further X entries (demand, up price) for current column. Considering group is "bull confirmed" would consider full position based on group strength. Longer-term risk/reward currently 17.9% risk, 33% reward (based off stop $16, target $26) while more attractive risk/reward from preliminary bullish count.

Analysis

The technical analyst is less concerned with P/E ratios, but simply based off of the technicals and risk/reward characteristics, one might find shares of Staples (SPLS) more attractive than Activision (ATVI). Sector strength also in favor of SPLS as "office products" stocks seem to have favor of MARKET, while "software" is weaker and may have "tech-like" association.

The fundamental analyst must be left to wonder why Staples (SPLS) is fetching such a lofty P/E multiple. Is the MARKET anticipating some type of future earnings event that may be cause for rise in stock price?

Jeff Bailey
Senior Market Technician
Option Investor

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