Stocks at Risk on 5th Anniversary of Highs

NEW YORK ( TheStreet) -- In this week five years ago, the Dow Industrial Average and S&P 500 set their all time highs at 14,198.10 Dow Industrials and 1576.06 S&P. Many on Wall Street and in the investment community view this anniversary as a non-event as the Nasdaq powered well above its November 2007 high at 2861.51 to a higher high this year at 3196.93 on Sept. 21.

I believe there is enough evidence among the performance of the major averages to heed the warning I present today: It is time to book profits and raise cash to at least 50%.

The Dow Transportation Average set an all-time high in July 2007 at 5487.05, then a higher high at 5536.57 in May 2008, and then its latest all-time high at 5627.85 on July 7, 2011. Transports are thus showing a five-year ceiling between 5487 and 5627. Transports have been trading back and forth around 5000 in 2012. This economically sensitive sector is providing an economic warning that the economy will continue to see slow to no growth despite the Federal Reserve's quantitative easing programs.

The Russell 2000 also has a ceiling that began with an all-time high at 856.48 in July 2007, and its latest all-time high is 868.57 set on May 2, 2011. An attempted breakout above this level occurred with the QE3 reaction high at 868.50 on Sept. 14, 2012. The inability for small stocks to lead is another warning in my judgment.

The PHLX Semiconductor Sector Index represents an important economically sensitive industry and its performance provides another economic warning as demand for chips has been sliding. The SOX set a high at 549.39 in July 2007, then a lower high at 474.33 on Feb. 18, 2011 and another lower high at 444.96 on March 27, 2012.

This series of lower highs since 2007 is another warning for the global economy. The SOX has a negative monthly chart profile and is below its 120-month simple moving average at 397.81.

Stocks are not cheap fundamentally as www.ValuEngine.com shows that 53.3% of all stocks are undervalued with 46.7% overvalued. Thirteen of 16 sectors are overvalued; medical by 15.9%, retail-wholesale by 13.4%, construction by 12.9%, utilities by 12.5%, finance by 12.4% and consumer staples by 12.4%.

My proprietary analytics provide key levels that help me project the upside potential and downside risk for the Dow Industrials and S&P 500. Both the Dow and S&P are positive but overbought on their weekly charts, and they began this week straddling key monthly pivots at 13,506 on the Dow and 1468.0 S&P.

The S&P 500 tested 1468.0 at last week high, but did not end the week above that level. On Tuesday Dow Industrials closed below 13,506, but the important close is on Friday.

Weekly closes above 1468.0 S&P targets quarterly and annual risky levels at 1513.3 and 1562.9 which are both below the October 2007 high at 1576.06. In this scenario strength on the Dow can stretch to its annual and quarter risky levels at 14,032 and 14,192, also shy of its October 2007 high at 14,198.10. It's tough to justify new long positions with this limited upside potential.

Weekly closes below 13,506 on Dow Industrials indicate risk to my annual value level at 1363.2 on the S&P 500 then below that is risk to my annual value level at 12,312 on the Dow Industrial Average. This risk/reward is not favorable, so the better strategy is to take some money off the table by booking profits and raising cash to at least 50%.

Over the past few weeks my stock market diagnosis has been that the market is catching what I call "QE fatigue." Under this contagion earnings warnings and weaker than expected economic data begin to offset "QE hype" where momentum for stocks continue to reach new all-time, multi-year or 2012 highs.

On Sept. 21 I wrote QE Fatigue Plagues Transports, May Be Contagious as the Dow Transportation Average plunged 5.8% that week.

On September 28 I wrote QE Fatigue Spreads from Transports to Semiconductors as the SOX gapped below its 50-day and 200-day simple moving averages.

As we entered the third quarter earnings season on October 5 I wrote 'QE Hype' and 'QE Fatigue' Tug of War Continues where I discussed the potential spreading of "QE fatigue" to three sectors: industrial products, oils-energy and basic industries in these stories.

The key this earnings season is the revenue line as major companies have the accounting flexible to meet or beat EPS estimates, but the slower economy makes it more difficult to beat on the bottom line. Another focus is earning guidance relative to the weakening global economies, the pending fiscal cliff, and election uncertainties.

All of these issues, the negative divergences among the major averages, and the overhead risky levels from my proprietary analytics justify my investment advice to book profits, take some money off the table and have an asset allocation in the stock market down to at least 50%.

I have made several "market-timing" calls at market extremes since this century began. Back in March 2000, I recommended that investors reduce exposure to the Nasdaq by 50% saying that gains above 5000 would not be sustained. Then in the second half of 2002 my call was to re-invest in the stock market.

In the second half of 2007 my advice was to book profits and raise cash just as I do in today's analysis. As March 2009 began I made the call that stocks were ripe for a 40% to 50% upside move.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
Richard Suttmeier has an engineering degree from Georgia Tech and a master of science from Brooklyn Poly. He began his career in the financial services industry in 1972 trading U.S. Treasury securities in the primary dealer community. In 1981 he formed the Government Bond Department at LF Rothschild and helped establish that firm as a primary dealer in 1986. Richard began writing market research in 1984 and held positions as market strategist at firms such as Smith Barney, William R Hough, Joseph Stevens, and Rightside Advisors. He joined www.ValuEngine.com in 2008 producing newsletters covering the U.S. capital markets, and a universe of more than 7,000 stocks. Richard employs a "buy and trade" investment strategy and can be reached at RSuttmeier@Gmail.com.