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Greenberg: Momentum King’s Next Big Move

Wednesday, 30 Mar 2011 | 4:25 PM ET

Over the years, when the market has gotten really wacky, tense and emotional, I have tended to always check in with the king of momentum investing: William O’Neil — or at least his organization, which includes Investors Business Daily.

I’ve actually never talked to O’Neil, but I’ve often been surprised to hear they were long gone from (or certainly cautious on) some of the biggest momentum names when the market — or at least a cluster of names — has appeared to have gotten out of control.

That’s when companies go from being just companies to being stocks.

With that in mind, what’s the current state of momentum?

Depends when you ask.

“The first thing we always look at is the direction of the market, and it’s unclear at this point.” Chris Gessel, executive editor of IBD, has worked with O’Neil for 15 years and serves as the front man to people like me.

We were talking late Tuesday morning — and at that point he was saying:

  • It’s a good time to be cautious buying stocks. “There are some opportunities, but we’re heading into a market that isn’t as clear as we’d like.” But that shouldn’t be surprising: Historically, according to the O’Neil archives, the third year of a recovery after a major bear market tends to be choppy.
  • Growth stocks tend to be more exaggerated in their ties to the market. If the market is down 10%, they’ll be down 20% and 30%. (And vice-versa.)
  • This is a very news-driven market, but even that statement is confusing. “In a strong bull market, no matter what the news, the market goes higher.” Yet in the world of O’Neil, the market is in an intermediate correction. “Historically, you would expect to see choppy sideways action, and that’s what we’re getting.”
  • The indexes are not looking well – certainly not as good as the leading stocks. “Either the market has to catch up or the stocks have to give up gains.”
  • Looming earnings adds another dimension of uncertainty. “If the market were much stronger, you wouldn’t have to worry about earnings, but we have the mixed message of the market indexes and leading stocks. You don’t see leading stocks run for prolonged periods without the market supporting them.”

Enter later in the afternoon, after the market closed. I checked back with Gessel and (surprise!) he had an update – proving just how unpredictable this market has become:

“We’re changing our outlook back to an uptrend because of the action of the leaders,” he said.

Does that mean the choppy and unclear nature of the market — with indexes in conflict with the leaders — is moot?

“It’s not entirely resolved” Gessel said. “But the leaders are acting very well and the market is okay. Today’s positive reversal and close right near the high after last week’s positive action is getting hard to ignore.”

What about the hottest stocks? Some of the big movers like Netflix, OpenTable, Chipotle and Apple are at points where Gessel says the O’Neil model might not commit new money “at this point.” (It tends to wait for the stock to start moving again with confirming volume.) "The big easier gains have passed and a lot more diligence and disciplined trading is required. You need to buy at the right point."

On the other hand, AthenaHealthis starting to show up on the O’Neil radar, thanks to accelerating sales and earnings. “It’s a fairly new stock for us,” Gessel says. “But it had been going sideways for four years.” Even though it’s nearly double its summer lows, Gesssel says, “You wouldn’t look at this and call this a momentum stock.”

Not yet, at least.

My take: Never forget the part about growth stocks and their exaggerated ties to the market. The markets may come and go but that never changes – both ways!

Questions? Comments? Write to HerbOnTheStreet@cnbc.com

Follow Herb on Twitter: @herbgreenberg

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