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At the end of the year, markets are at the crosscurrents of all sorts of trends that magnify market volatility. This year, in addition to the usual January effect and the end of the year window dressing, markets are on the edge because of another trend, the ongoing European sovereign debt woes that have caused a major correction in the price of most stocks.

Particularly hard hit have been momentum “angels,” as they appeal more to the emotional rather than to the rational side of investors. Compounding the correction, some momentum stocks have problems of their own that have turned the tide on the short rather than the long side. This means that some momentum stocks have been unfairly penalized. They have turned into fallen angels—presenting a buying opportunity. At the same time, other momentum stocks have been fairly penalized. They are falling angels—presenting a trap.

To help investors distinguish between the two groups, we first classify momentum stocks into two categories, American and Chinese, and review which stocks have been fairly or not fully-penalized and which have been unfairly penalized or fully penalized. American momentum stocks are mostly concentrated into social media space, but they also come from all sorts of sectors, including clothing, carbonated drinks, restaurants, etc.; they have dropped anywhere from 15 to 40 percent.

Among the American momentum stocks, Netflix (NFLX), Open Table (OPEN), Lululemon (LULU) and Green Mountain Coffee (GMCR) have been fairly punished, as their fundamentals have shifted—they have disappointed investors in terms of their growth potential or the soundness of their business, while Chipotle (CMG) has been unfairly punished, as it trades at reasonable PEs, and its fundamentals remain intact. Another momentum stock Research in Motion (RIMM) may have been fairly punished because of a string of earnings and sales disappointments, but it is trading at a price that may be a good take-over target; it is a fallen angel.

Company

Business

Angel Status

Action

Netflix

Video streaming

Falling

SA

Open Table

On-line reservation system

Falling

SA

Lululemon

Athletic apparel

Falling

SA

Chipotle

Mexican restaurant chain

Fallen

B

Research in Motion

Home beverage carbonation systems

Fallen

B

Green Mountain Coffee

Coffee machines and supplies

Fallen

SA

B: Buy

SA: Stay away

Among Chinese momentum stocks, Dangdang (DANG) and Renren (RENN) have been fairly punished, as they trade at an astronomically high PE and shaky fundamentals, Baidu (BIDU), Sina (SINA), Sohu (SOHU), and Youku (YOKU) have been unfairly punished, as they trade at reasonable PE and sound fundamentals.

Company*

Business

Angel status

Action

Baidu, Inc.

Internet search engine

Fallen

B

Sina Corp

Media and mobile value-added services

Fallen

B

E-Commerce China Dangdang Inc.

Business –to-Consumer e-Commerce

Falling

SA

Renren Inc (

Social Networking

Falling

SA

Youku.com

Internet TV

Falling

B

Sohu.com Inc.

Brand advertising, on-line gaming

Fallen

B

Source: Yahoo.finance.com

The bottom line: Investors should consider buying into momentum stocks that have been unfairly punished or fully punished, but stay away from momentum stocks that have been fairly punished or not fully-punished. That’s the evidence from the bubble of the late 1990s. Ten years after the momentum faded, high fliers like (CSCO), Ciena Corp (CIEN), and JDS Uniphase (JDSU) are trading at a small fraction of peak-bubble prices.

Disclosure: I am short NFLX, LULU.

Source: Falling Vs. Fallen Angels: Which Momentum Stocks To Buy, Which To Avoid