Chips Are No Bargain

The move in this sector has created risky moves in several semiconductor stocks.
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Over the past two years, the chipmakers have gone from having too much inventory to not having enough capacity to meet demand.

Consumers around the world are purchasing the latest consumer electronic devices -- PCs, cell phones, digital cameras, flat-panel televisions and MP3 players -- to such an extent that the Semiconductor Industry Association (SIA) said on Jan. 3 that worldwide sales of semiconductors reached $20.4 billion in November, up 7.2% year over year, and up 1.7% sequentially.

However, semiconductors are no longer cheap. In fact, the semiconductor industry, which was 32.9% undervalued in April when I made my bullish call, is now just 7.6% undervalued. This makes the highly speculative tech sector a tough place for the long-term investors to begin new positions.

The benchmark for the semiconductors is the Philadelphia Semiconductor Index (SOX).

Back in July I tracked the bullish crossover, where the five-week modified moving average crossed above the 200-week simple moving average for the first time since November 1998. This was a reason I cited for projecting that the chipmakers would lead a tech rally. Now the weekly chart profile for the SOX has become overbought, with the five-week MMA at 498.33, well above the 200-week SMA at 418.05. Wednesday's strength has the index approaching my monthly risky level at 535.41 as I write this column.

To further illustrate the risk, some of the chip names I profile today have become dangerously overvalued, but are trading to new 52-week highs for reasons that only the disciplined trader can decipher. Many of the chart patterns have become parabolic and reminiscent of six years ago. Investors should consider exit strategies, and traders should just beware that trees don't grow to the sky.

My theme in columns published in December was that it would be wise to use the market's year-end strength to reduce holdings. I know that a few of these stocks exploded to the upside as 2006 began, but I stand by my guidance to reduce holdings by 25% and then review again in early 2006.

Advanced Micro Devices

(AMD) - Get Report

reached another 52-week high earlier on Wednesday, and clearly has the hype and momentum to move even higher. Keep in mind that AMD's recent gain is based partially upon speculation that

Dell

(DELL) - Get Report

will be shifting to AMD chips this year.

Piper Jaffray upgraded AMD earlier this week to outperform from market perform on the increasing likelihood of a Dell chip-switch in the second half of 2006. Keep in mind that similar rumors were circulating a year ago, but Dell stuck with

Intel

(INTC) - Get Report

. According to Yahoo! Finance, the P/E for AMD is 513.7, which makes it tough for the long-term investor to consider.

The stock is rated a sell by ValuEngine, and is 79.3% overvalued with fair value at $19.48. The weekly chart profile is overbought, with the five-week MMA at $30.08. Strength so far this month has pushed shares above my monthly pivot at $32.52, and I do not show a risky level. This is a sign that AMD is a pure momentum trade entering its parabolic phase, where you cannot say how high shares can trade.

Long-term investors should thus consider using a close below $32.52 as a sell-stop to protect gains. Below $32.52 is an annual pivot at $28.61, and a monthly value level at $27.00.

Altera

(ALTR) - Get Report

is rated a hold by ValuEngine. The stock is 21.4% undervalued, with fair value at $24.87. The weekly chart profile is positive, with the five-week modified moving average (MMA) at $19.04 and the 200-week simple moving average (SMA) as support at $18.57.

The long-term investor should consider adding to this position on weakness to my monthly value level at $18.56. If you are looking to book profits on strength, consider doing so at my quarterly risky level at $21.68.

Lam Research

(LRCX) - Get Report

, rated a hold by ValuEngine, is 31.5% overvalued, and fair value appears at $29.47. The weekly chart profile is overbought, with the five-week MMA at $36.97.

Long-term investors should consider reducing this position by 25% on strength to my annual risky level at $40.07, or on a sell-stop below my quarterly pivot at $35.31. I show semiannual and quarterly value levels at $29.07 and $26.00, with an annual pivot at $34.68 and monthly risky level at $39.43.

Marvell Technology

(MRVL) - Get Report

is 35.8% overvalued, with fair value at $47.88. The stock is rated a hold by ValuEngine, and the weekly chart profile is overbought, with the five-week MMA at $58.22. Shares reached another 52-week high at $66.25 Wednesday morning. The strength thus far in January has moved the stock above my monthly pivot at $62.16, and I do not show a risky level. Like AMD, this indicates that Marvell is a pure momentum trade entering its parabolic phase, where you cannot say how high shares can trade.

Long-term investors should thus consider using a close below $62.16 as a sell-stop to protect gains. Below $62.16 is my monthly value level at $52.20.

Novellus

(NVLS)

is rated a hold by ValuEngine. This stock is 28.1% undervalued, with fair value at $34.81. The weekly chart profile shows rising momentum and is above its five-week MMA at $24.69.

Novellus has lagged on two brokerage downgrades -- Susquehanna Financial downgraded shares to neutral from positive, and Morgan Stanley downgraded to underweight from equal weight. Long-term investors should consider adding to this holding on weakness to my semiannual value level at $21.23. If you are looking to book profits on strength, consider doing so at my monthly risky level at $26.99.

National Semiconductor

(NSM)

, rated a hold by ValuEngine, stands at 25.5% overvalued, with fair value at $22.64. The weekly chart profile shows rising momentum, with the five-week MMA at $26.90, and shares reached another 52-week high at $28.76 on Monday.

Long-term investors should consider reducing this position by 25% on strength to my monthly risky level at $29.47, or on a sell-stop below my quarterly pivot at $26.55. My monthly value level is $26.40.

Rambus

(RMBS) - Get Report

is rated a sell by ValuEngine. This stock is 229.2% overvalued with fair value at $8.60. The weekly chart profile is overbought with the five-week MMA at $19.26. Shares reached another 52-week high at $31.96 this morning on an upgrade to buy from hold by WR Hambrecht.

For the third time in this column, this stock does not show a risky level, so this is a pure momentum trade entering its parabolic phase, where you cannot say how high shares can trade. Shares traded as high as $36.56 in January 2004. Just beware that if there is a price correction, my nearest value level is my semiannual value level at $24.03.

Sigma Designs

(SIGM)

is 103.1% overvalued, with fair value at $7.89, and is rated a sell by ValuEngine. The weekly chart profile is overbought, with the five-week MMA at $14.33. Shares reached another 52-week high at $16.20 Wednesday morning.

Long-term investors should consider reducing this position by 25% on strength to my semiannual risky level at $16.24, or on a sell stop below my monthly pivot at $14.58. My semiannual value level is at $12.70.

Finally,

Xilinx

(XLNX) - Get Report

is rated a hold by ValuEngine. The stock is 17.3% undervalued with fair value at $35.38. The weekly chart profile has rising momentum with the five-week MMA at $27.09, and with shares just above its 200-week SMA at $28.74. Long-term investors should consider adding to this position on weakness to my monthly value level at $26.03. If you are looking to book profits on strength, consider doing so at my quarterly risky level at $32.49.

My Metrics Explained

I evaluate the U.S. capital markets and profile all sectors, industries or specialty groups of companies. There are more than 6,000 stocks in my database.

Remember that when investing and trading in the U.S. capital markets and specific stocks, decisions should be made only after evaluating both fundamental and technical considerations. It is also equally important to manage risk/reward by having levels at which to buy on weakness and sell on strength. The way to do this is to enter limit orders to buy at a price below the market, or to sell at a price above the market.

Combining fundamentals and technicals is like trying to mix oil and water, but I believe it is necessary to do so to the best of your ability. The levels at which to buy or sell can be used regardless of the fundamentals or technicals.

My discipline involves a three-pronged approach to measuring the risk/reward for trading or investing:

Fundamental

I use ValuEngine to define my fundamental 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.

Weekly Chart Momentum

This approach measures the technical strength of a stock.

Overbought

: 12x3 weekly slow stochastic above 80 on a scale of zero to 100.

Rising

: 12x3 weekly slow stochastic rising above 20, but below 80.

Flat

: 12x3 weekly slow stochastic not rising or declining, but between 20 and 80.

Declining

: 12x3 weekly slow stochastic is declining below 80, but above 20.

Oversold

: 12x3 weekly slow stochastic is below 20 on a scale of zero to 100.

Key Technical Levels

I identify these as a price at which to buy on weakness and at which to sell on strength.

Moving averages on daily charts

: The 21-day, 50-day and 200-day simple moving averages (SMAs).

Moving averages on weekly charts

: The five-week modified moving average (MMA) and the 200-week simple moving average (SMA).

Value levels and risky levels

: My model includes proprietary analytics that evaluate the past nine closes in several time horizons: weekly (W), monthly (M), quarterly (Q), semiannually (S) and annually (A).

P.S. For those interested in hearing thoughts on 2006 from me and

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Cody Willard, James Altucher and Lenny Dykstra,

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Richard Suttmeier is president of Global Market Consultants, Ltd., chief market strategist for Joseph Stevens & Co., a full service brokerage firm located in Lower Manhattan, and the author of

TheStreet.com Technology Report

newsletter. At the time of publication, he had no positions in any of the securities mentioned in this column, but holdings can change at any time. 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. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he invites you to send your feedback --

click here

to send him an email.