3 Stocks to Sell Ahead of Market Correction

MINNEAPOLIS (Stockpickr) -- They say animals can sense natural disasters long before they arrive. Can humans predict the same when it comes to the market?

For those with a sixth sense or intuition perhaps it is possible to see trouble coming before it hits. Some may scoff at such a notion when it comes to stocks, but I would suggest that signals of a correction or worse do make themselves apparent to those listening to the winds of the market.

We are witnessing such a moment now. Stocks have risen almost uncontrollably and without pause since Labor Day. Gains for 2010 are now solidly in double digits, and many predict even bigger gains for 2011.

Within such predictions, there is trouble brewing. Perhaps it is the avalanche of bullish behavior itself that suggests that a correction is on its way, or maybe such a correction can be seen by examining the charts or some other technical indicator such as the volatility index or VIX.

Related: Stocks to Lead the Market in 2011

On a micro basis, there are some troubling signs for stocks, at least in the near term. Aside from the basic premise of the market's being overdue for a correction, a few individual stocks look to be tired.

For example, Apple ( AAPL) appears to have hit an exhaustive peak despite having product sales success on a mammoth scale. And what about the selling in momentum stock stalwart Netflix ( NFLX)?

Beyond those too large and important names are stocks such as Nike ( NKE) and Cal-Maine Foods ( CALM). Both of those names released earnings recently that included warnings about future performance being negatively impacted by higher input costs.

With companies unable to charge higher prices on the retail level, higher production costs eat away at profit margins. Smaller profits result in market selloffs of individual names noting such an impact, as we saw with both Nike and Cal-Maine.

I do not believe the current situation indicates that a massive selloff is lurking, but I do think a correction of some sort will be forthcoming. Add in recent economic data that showed housing prices slipping for the fourth straight month or lower-than-expected consumer confidence, and the stage is set for some sort of across the board selling.

Here, then, are three names to consider selling in advance of a correction.

DuPont

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This massive chemical company has seen its stock nearly double in 2010, but those gains may be short-lived as rising oil prices eat into profit margins. With oil being the core ingredient for most chemicals made by the company, profit estimates are likely to be too high.

Wall Street analysts are notoriously slow to reduce estimates. They prefer steady growing profits. They also do not do well when things are moving quickly, as is the price of oil. Call it denial, but the fact remains that 2011 will be a tougher year as commodity prices move higher.

The current 2011 estimate for DuPont ( DD) is $3.52. Look for those numbers to dip after the company releases results for the December period if it states that rising manufacturing costs are indeed negatively impacting profits.

At current prices, shares of DuPont trade for a very hefty 14 times the 2011 earnings estimate. A more reasonable multiple for what I would define as a more conservative, defensive stock would be less than 10 times.

DuPont is facing a double whammy of high valuation combined with earnings growth that will deteriorate with higher input prices and minimal ability to pass on increases to the consumer.

Shares are likely to fall in the near future.

On the other hand, DuPont is a top holding of Brian Rogers' T. Rowe Price Equity Income fund, and Robert Olstein Richard Snow also have bullish bets on the stock. Jim Cramer recently called it one of the greatest American manufacturer stocks, and it's poised to be one of the highest-yielding Dow stocks for 2011.

United Airlines

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Airline stocks have done very well during the early stages of the economic recovery. Mergers and acquisitions have reduced capacity. At the same time, airlines have resisted the urge to saturate markets with extra seats. If anything, airlines are removing seats in order to create upward pricing pressure on tickets.

It is entirely possible that the industry has mortgaged its future if consumers become less willing to pay higher prices in the future. Rising oil prices will be met with ticket surcharges if accepted by the still-fragile consumer.

The more-likely outcome will be smaller profit margins and therefore lower stock prices. One airline that may be a bit more vulnerable to a decrease in stock value is United Airlines ( UAL).

Its shares were up more than 100% in early December before retreating a bit. The 10% drop since the start of the month can be directly attributed to higher fuel costs but is just the beginning of what might be a drop of more than 30% before any correction is complete.

Although shares are cheap based on the 2011 estimate of $5.02, a big miss based on lower profits due to higher oil prices makes shares expensive. Airline earnings are notoriously volatile, hence the low valuation.

$150 oil that some expect in 2011 could cut the current estimate in half. A 10% to 20% drop in price from current levels is likely.

On the other side of the fence, one big bullish bet on United comes from Bill Miller's Legg Mason Capital Management, which increased its position in the stock by 83.5% in the most recent period. Ted Reed recently highlighted United as one of the four airlines with the highest fee revenue in the first three quarters of 2010, and Jonas Elmerraji posited a potential short squeeze in the stock. Nainesh Shah, portfolio manager for the five-star Roosevelt Multi Cap fund, said the Fed's easy money policies could give United a lift in 2011.

Old Dominion Freight

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Keeping in the theme of transportation, the domestic trucking sector is also vulnerable to a significant pullback during any market correction. Here the analysis is simple: The single most important cost in running a trucking business is oil. If the price of oil increases, trucking firms make less money.

It is that simple. Going further, if trucking firms do not have the ability to increase prices to customers, profits will surely fall.

When the recession began at the end of 2007, oil prices had a run to nearly $150 per barrel. Combined with heavy competition followed by a deep recession and many trucking firms collapsed or failed entirely.

One of the big names that fell on hard times was YRC Worldwide ( YRC). Debt restructuring and reorganization has yet to bring the company back to its former self.

Conditions today are nowhere near as harsh, but a drop in stock prices is likely across the sector. Old Dominion Freight ( ODFL) is the name I would sell here. The company is a survivor, and its stock has gained more than 50% in 2010.

The company is expected to earn $1.73 in 2011. Shares now trade for 18 times that number. Investors can expect the company to miss that estimate if oil prices continue to surge next year.

A 10% to 20% drop in the stock is not out of the question.

On the flip side, with an A- buy rating from TheStreet Ratings, Old Dominion is one of its top-rated trucking stocks.

To see these stocks in action, visit the 3 Stocks to Sell for a Coming Correction portfolio.

-- Written by Jamie Dlugosch in Minneapolis.

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At the time of publication, author had no positions in stocks mentioned.

Jamie Dlugosch is a founder and contributor to
MainStreet Investor and MainStreet Accredited Investor . Formerly, he was president and CEO of Al Frank Asset Management. He has contributed editorially to The Rational Investor , The Prudent Speculator , Penny Stock Winners and InvestorPlace Media .

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