Be Careful in an Overvalued, Overbought Market

NEW YORK (TheStreet) -- I debuted my themes for the 2014 stock market on Jan. 2 in, "Stocks Begin 2014 With Inflating Bubbles." I explained that even if new intraday all-time or multiyear highs continued to occur, the downside risk exceeds the upside potential for the five major equity averages. Overly simplified, my market call for 2014 is that the major averages will test their 200-day simple moving averages at some point during the year.

I have been saying that stock picking would be extremely difficult in an overvalued, overbought stock market. (On Jan. 8, I wrote "Inflating Market Bubble Not Quite Ready to Pop.") I maintain my long-term concerns about the stock market.

The Fundamentals -- ValuEngine continues to show an extremely overvalued stock market. We show that 85.2% of all stocks are overvalued, with 53.3% overvalued by 20% or more. Only 14.8% are undervalued, and only 4.8% are undervalued by 20% or more. All 16 sectors are overvalued, with 12 overvalued by 23% to 38.2%. This is the reason why you see stocks plunge by 10%, 20% or more following disappointing earnings or other stock-specific negative news.

Difficult stock picking is exemplified by Best Buy (BBY)(26.83). The retailer plunged by 28.6% on Thursday when they reported weaker than expected holiday sales. The stock opened well below its 200-day simple moving average at $33.74 and is still 8.5% overvalued. The stock closed between my quarterly value level at $24.82 and my annual pivot at $27.34.

The Weekly Technicals -- All five major equity averages have positive but overbought weekly chart profiles. I define "overbought" as weekly closes above five-month modified moving averages with 12x3x3 weekly slow stochastic readings above 80 on a scale of 0 to 100. To confirm cycle highs, we need to have simultaneous weekly closes below five-week MMAs for all five major equity averages, with the stochastic readings declining below 80. That would be my signal of a major market top with risk to the 200-day simple moving averages, which were not tested at all in 2013.

Some momentum stocks continue to lead. For example, Google (GOOG)($1156.22) set another all-time intraday high yesterday. But how many retail investors want to buy a stock trading at $1,156.22 per share when the stock is 45.9% overvalued, with a one-year price target at $1,178.15 according to ValuEngine?

My Proprietary Analytics -- Four of the five major equity averages set new all-time or multiyear intraday highs on Jan. 16, except the Dow Jones Industrial Average, which set its all-time high of 16,588.25 on Dec. 31. The Dow traded down to 16,240.60 on Jan. 13, holding its semiannual value level at 16,245. It then rebounded to 16,505.28 on Jan. 15, as my monthly pivot at 16,327 proved to be a magnet. The 200-day SMA is 15,398, which is between my annual value levels of 14,835 and 13,467. If stocks continue to set new highs the upside to my quarterly and semiannual risky levels is at 16,761 and 16,860.

A stock pick that could have been avoided is Dow component Intel (INTC) ($26.54). The stock was downgraded to hold from buy by ValuEngine earlier this week, so it's not a shock that the stock fell 5% after hours on Thursday. The stock was 26% overvalued, with a one-year price target at $27.55 vs. its multiyear intraday high at $27.12 set on Dec. 15. The high was between my semiannual pivot at $26.33 and my semiannual risky level at $28.95.

The S&P 500 opened 2014 below my monthly pivot at 1847, which warned that there would be some early-January weakness. The S&P traded down to 1815.52 on Jan. 13, then returned to 1847 as the "power of the pivot" indicated an 85% chance of a re-test of that monthly pivot. The S&P set a new all-time intraday high at 1850.84 on Jan. 15. My semiannual value levels are 1797.3 and 1764.4, with my quarterly risky level at 1896. My lower annual value levels are 1539.1 and 1442.1, and are below the 200-day SMA at 1694.5.

The Nasdaq set a new multiyear intraday high at 4219.28 on Jan. 16, still shy of my monthly and quarterly risky levels at 4267 and 4274. My semiannual value levels are 3930 and 3920, with annual value levels at 3471 and 3063, which are below the 200-day SMA at 3689.

The Dow Transportation Average began 2014 trading down to 7228.93 into Jan. 6, through my semiannual and monthly pivots at 7376 and 7327, but held my semiannual pivot at 7245. Transports then rebounded, helped by the "power of the pivots" that were violated on the downside. Transports set a new all-time intraday high at 7508.74 on Jan. 15. My quarterly value level is 7086 with the semiannual and monthly pivots at 7245, 7327 and 7376. My annual value levels ate 6249 and 5935, which are below the 200-day SMA at 6625.

Another example of a tough stock pick is railroad company CSX Corp (CSX) ($27.24), which matched earnings per share estimates and earned 42 cents a share afterhours on Jan. 15. The stock closed that day at a new all-time high at $29.24, then opened Jan. 16 below its 50-day SMA at $27.66 to a day's low at $26.76, down 8.5%. Even after this report, the hold-rated stock is 16% overvalued, and the low approached the ValuEngine one-year price target at $26.22. CSX has a quarterly value level at $26.82, which held at the low.

The Russell 2000 set its latest all-time intraday high at 1173.13 on Thursday, still below my quarterly and monthly risky levels at 1180.35 and 1200.55. My semiannual value levels are 1130.79 and 1133.29, with my annual value levels at 966.72 and 879.39, which are below the 200-day SMA at 1046.39.

When you observe all of these value levels, pivots and risky levels you can see why I describe the combination as a tangled bowl of spaghetti. This is why the major averages can continue to chop around between these levels until there's a catalyst that fuels a break-out above 16,860 on the Dow Industrials, 1896 on the S&P 500, 4274 on the Nasdaq and 1200.55 on the Russell 2000, or there are weekly closes below 16,245 for the Dow Industrials and 7245 for the Dow Transports.

The weekly chart profiles hold the keys for confirming a stock market peak. The configuration that signals 18% to 27% declines for the major averages are simultaneous weekly closes below the five-week modified moving averages at 16,157 for the Dow Industrials, 1809.9 for the S&P 500, 4073 for the Nasdaq, 7242 for the Dow Transports and 1139.15 for the Russell 2000 with the 12x3x3 weekly slow stochastic readings declining below 80 on a scale of 0 to 100. These readings are currently 89.95 for the Dow Industrials, 92.77 for the S&P 500, 94.48 for the Nasdaq, 93.20 for the Dow Transports and 91.53 for the Russell 2000. Each week, the five-week MMAs will be rising.

At the time of publication the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff

Richard Suttmeier is the chief market strategist at ValuEngine.com. He has been a professional in the U.S. Capital Markets since 1972, transferring his engineering skills to the trading and investment world.

Suttmeier has an engineering degree from Georgia Tech and a Master of Science degree from Brooklyn Poly. He began his career in the financial services industry in 1972 trading U.S. Treasury securities in the primary dealer community. He became the first long bond trader for Bache in 1978, and formed the Government Bond Department at LF Rothschild in 1981, helping establish that firm as a primary dealer in 1986. This experience gives him the insights to be an expert on monetary policy, which he features in his newsletters, and market commentary.

Suttmeier's industry licenses include, Series 7 and Registered Principal (Series 24). He has been the Chief Market Strategist for ValuEngine.com since 2008 and often appears on financial TV.

Click here for details on Suttmeier's "Buy and Trade" investment strategy.

Richard Suttmeier can be reached at RSuttmeier@Gmail.com

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