The U.S. equity averages were quite strong in the first quarter, despite deteriorating valuations, higher interest rates and building commodity price inflation. But going into the second quarter, I can't be bullish on stocks because of the overvalued fundamentals. However, I can't be bearish, given the positive weekly chart profiles for every major average except Dow Utilities.

In my judgment, a bull market for U.S. stocks requires the majority of sectors to be undervalued and all key averages to be simultaneously technically positive. This is not the case as the second quarter begins.

With the weekly chart profiles showing overbought momentum for most U.S. equity averages, investors should be focusing on the weekly chart profiles for the stocks in their portfolios. Stay with the strong stocks moving higher, but do not add new money to these positions. If a particular holding has become more than 10% of a diversified portfolio, a prudent investment strategy is to pare back that holding to 5%.

To handle what I expect to be a tricky second quarter, investors need to learn how to think as traders and reduce holdings on strength to risky levels and have a sell stop to protect gains when the overbought momentum phase ends. To help with this, in my columns I focus on the strong stocks that have gone parabolic and provide exit strategies. I also identify the stocks that are rated strong buy and buy according to ValuEngine and those that are undervalued, and provide entry strategies. Often, after a stock breaks its parabolic, it becomes a falling knife; think of Apple and Google in the first quarter, which both peaked in January, declined by more than 25% and tested their 200-day simple moving averages in March. My model provides levels at which to rebuild positions on weakness.

All sectors of the market are much more overvalued today than at the end of 2005. The three most important inputs to valuations are the 12-month trailing earnings per share, 12-month forward EPS estimates from Wall Street analysts and the yield on the 30-year Treasury. Recent quarterly results were for the most part above expectations, but while Wall Streeters may talk about a stronger stock market this quarter and beyond, they aren't backing that up with higher EPS estimates. The yield on the 30-year bond was up 47 basis points in the first quarter, which was a pure drag on valuations.

Every sector is overvalued by more than 8.5% except technology, with basic materials the most overvalued, at 23.7%. Technology began the year 10.5% undervalued and ended the first quarter 1.2% overvalued.

Chart Profiles and Key Levels

The

Dow Jones Industrial Average's

monthly chart shows rising momentum with the weekly chart overbought. As long as weakness holds new monthly and quarterly supports at 10,935 and 10,883, the momentum rally continues. This week's resistance at 11,423 is below the January 2000 high of 11,750. A weekly close below 10,883 should begin a correction toward my semiannual support at 9968. The upside for 2006 should be limited to my annual resistance at 12,648.

The monthly and weekly charts for the

S&P 500

futures show overbought momentum. Monthly support is 1280.9, with a quarterly pivot at 1308.3 and weekly resistance at 1329.5. My semiannual support is 1074.0, with annual resistance at 1446.3.

The upside for the Nasdaq in 2006 should be limited to my annual resistance at 3009. The monthly chart shows overbought momentum, with the weekly chart showing rising momentum. Monthly and quarterly supports are 2288 and 2275, with a weekly pivot at 2336 and monthly resistance at 2382. A weekly close below 2275 would indicate risk to my semiannual support at 1853.

Declining momentum marks both the monthly and weekly charts for the Dow Utilities. The index also holds the dubious honor of being the only major average to post a loss in the first quarter, declining 4.0%. Utilities are down 11.3% since testing an all-time high at 438.74 in October 2005. Annual support is 377.80, with weekly and monthly resistances at 400.05 and 414.02. Semiannual support is 331.95, with quarterly resistances at 435.59 and 445.27. The monthly chart profile stays negative on a monthly close below the five-week MMA at 397.87. The Utility Average is below its 200-day SMA for the first time since April 2003. If the 50-day SMA (now at 406.55) falls below the 200-day SMA of 404.30, it would be for the first time since crossing above in May 2003.

The Dow Transports' monthly and weekly charts show overbought momentum. The transports reached an all-time high at 4640 on Monday, just below my monthly resistance at 4643. Quarterly support is 4293, with a monthly pivot at 4530 and weekly and monthly resistances at 4704 and 4776. A weekly close below 4530 will warn that the momentum train is ending for the Dow Transports.

The monthly and weekly charts of the Russell 2000 futures show overbought momentum. The Russell 2000 reached an all-time high at 775.00 on Monday, and I do not show a longer-term resistance. Quarterly and monthly supports are 735.93 and 723.77, with a weekly pivot at 763.42.

Another reason for caution as the second quarter begins is the Philadelphia Semiconductor Index (SOX). The monthly chart shows rising momentum, while the weekly chart shows declining momentum. While being up 4.2% in the first quarter, the SOX is down 10.7% since peaking at 559.60 on Jan. 27. Quarterly support is 422.38 with weekly and monthly resistances at 502.64 and 504.32. A weekly close above 504.32 would indicate that semiconductors can return to an upside leadership role.

Guidelines for Portfolio Trading

My profile for a stock is based on standard tools of technical analysis, my proprietary analytics developed more than 20 years ago and fundamental information available in the public domain. To pick stocks you need a fundamental valuation, a technical roadmap and levels at which to buy on weakness or sell on strength.

Fundamental Screens:

I use data from ValuEngine.com. My fair value is the price at which a stock can trade in a perfect world. Fair value is not a price target; it is based on a stock's past data and projections for the future, including the trailing 12-month EPS, the forward 12-month estimated EPS from Wall Street analysts and the yield on the 30-year Treasury bond. How these data points are weighted is based on a historical analysis of the stock's price history along with 17 other variables that influence the calculation based on the stock's sector and industry group. Data to formulate fair value are uploaded to ValuEngine overnight from Thomson/First Call and Capital IQ.

ValuEngine provides a rating for more than 4,000 stocks, which are based on a bell-shaped curve; only 2% are strong buys, 15% are buys, 63% are holds, 15% are sells and 5% are strong sells. Here's how I use the ratings:

  • Strong buy: Long-term investors should start a position now.
  • Buy: Buy on weakness to a value level.
  • Hold: Add to an existing position on weakness to a value level, and reduce an existing position on strength to a risky level.
  • Sell: Reduce on strength to a risky level.
  • Strong sell: Liquidate now as a source of funds.

Firm-specific variables that are inputs to stock valuations:

  • The correlation between the company's earnings per share and the interest rate environment
  • Long-term earnings growth rate
  • The duration of the company's business growth cycle
  • The company's systematic or beta risk
  • Interest-rate-related criteria
  • Long-term history of interest rate climate
  • Interest rate volatility
  • The duration of the interest rate cycle

Weekly Chart Profile:

A stock with a positive profile has a weekly close above its five-week modified moving average (MMA) with a rising 12x3 weekly slow stochastic, which is a measure of momentum on a scale of zero to 100. A reading above 80 is overbought. A stock with a negative profile has a weekly close below its five-week MMA with a declining 12x3 weekly slow stochastic. A reading below 20 is oversold.

  • Overbought: 12x3 weekly slow stochastic above 80 on a scale of zero to 100.
  • Rising: 12x3 weekly slow stochastic rising above 20, but is below 80.
  • Flat: 12x3 weekly slow stochastic between 20 and 80, but not rising or declining.
  • Declining: 12x3 weekly slow stochastic is declining below 80, but is above 20.
  • Oversold: 12x3 weekly slow stochastic is below 20 on a scale of zero to 100.
  • Moving averages on daily charts: the 21-day, 50-day and 200-day simple moving averages.
  • Moving averages on weekly charts: the five-week modified moving average (MMA) and the 200-week simple moving average (SMA).

Value Levels, Risky Levels and Pivots

A value level is a price at which buyers should emerge on share-price weakness. A risky level is a price at which sellers should reduce holdings on share-price gains. A pivot is a value or risky level that was violated in its time horizon, acting as a magnet during the remainder of that time horizon. These levels are calculated in weekly (W), monthly (M), quarterly (Q), semiannual (S) and annual (A) time horizons, based on the past nine closes in each time horizon. My theory is that the closes over a nine-year period are the summation of all bullish and bearish events for that market or specific stock.

Richard Suttmeier is president of Global Market Consultants, Ltd., and chief market strategist for Joseph Stevens & co., a full service brokerage firm located in lower Manhattan. Early in his career, Suttmeier became the first U.S. Treasury Bond Trader at Bache. He later began the government bond division at L. F. Rothschild. Suttmeier went on to form Global Market Consultants as an independent third-party research provider, producing reports covering the technicals of the U.S. capital markets. He also has been U.S. Treasury Strategist for Smith Barney and chief financial strategist for William R. Hough. Suttmeier holds a bachelor's degree from the Georgia Institute of Technology and a master's degree from Polytechnic University.