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2HRS2GO: Momentum traders stop following their Micromuse

3 min read

COMMENTARY -- Prophecies rarely fulfill themselves as obviously as a Micromuse (Nasdaq: MUSE) call did today.

Leave it to Wall Street to end the week acting even more irrationally than usual. MUSE shares gapped down 15.5 percent at the market opening and remains more than 8 percent lower than yesterday's close after Wit Soundview analyst Gary Spivak told people to buy the stock.

Let's see ... The analyst reiterates a Strong Buy, so I think I'll Sell... What a great idea!

Ok, I'm oversimplifying things. Here's the crux of Spivak's note today, from Wit Soundview's morning research highlights:

    "We believe there is negative news coming out on MUSE in the near future. We expect to hear about a significant relationship between two MUSE competitors tonight, with a large company licensing the technology of a smaller company. There is also a discussion within an industry analyst group that is likely to point to heightened competition by Riversoft and other OSS vendors. While we expect the stock to react negatively and suggest to wait until the dust settles, we would approach it as a good buying opportunity."

Spivak points to an announcement later in the day and fears it will spook MUSE investors. He tells you it's a good time to buy. Or put another way: "Don't sell if the stock falls. Add to your position instead."

Whether Micromuse is a good company (seems to be, based on financials) or overvalued stock (probably) hardly matters. Spivak made a prediction about the stock's trading action, not a fundamental call. Nothing about the company has changed from the analyst's point of view.

And if you have enough faith in the analyst to accept his word about "negative news", why ignore the rest of the note? Yet people clearly didn't heed the last sentence.

Given today's reaction to what was basically a mild research notation, it's obvious that MUSE's investor base has always been fragile to begin with. Shareholders were riding this momentum wave like something out of 1999, but no stock is going to last long at a multiple of 252 times estimated earnings, especially in the current market.

You might wonder why Spivak bothered to disseminate this information, but assuming his sources are accurate -- and we have no reason to believe otherwise -- he has to say something. Analysts are supposed to be ahead of the curve.

Still, no one can say if this particular curve would have even existed if not for Spivak's note. Perhaps the analyst was trying to get bad news out of the stock early. Message board paranoiacs would no doubt raise accusations about market manipulation.

I doubt it, but even if it's true, so what? Recognize the market for what it is and react accordingly. In this case, MUSE has clearly been a market toy since September:

Walk it up, take it down, start the cycle again. A richly-valued stock like MUSE is begging to be victimized by chart games.

Spivak's note, intentionally or not, provided a catalyst for the momentum players to cash out. If you were just playing MUSE, you're already gone.

Now if you're holding MUSE for the long haul, should you hang in there and relax? After all, the fundamentals haven't changed. Companies are still buying Netcool suites, because the need to monitor network performance hasn't disappeared. And you could argue that the bad news has already been priced out of the stock.

Conventional wisdom dictates against selling on a downward trend, but despite what Spivak says, it might not be a bad idea to look for an exit point, rather than a buying opportunity. Today's action underscores the fact that MUSE is already priced for perfection; you're not likely to see a much better level than the stock's price prior to today's sell-off.