Tech Disappointers Provide Warning for 2006

The earnings bar was set too high, and we'll see if more techs are due to get beaten by it.
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The bar was set too high for tech stocks as earnings season began last week, as I indicated. Because of that, four out of the seven stocks I profiled were taken to the woodshed, one turned out to be a sidewinder and only two traded higher. And both of those fell during Friday's market reversal. After such significant action, I want to revisit those profiles, and also consider the setup for Texas Instruments (TXN) - Get Report, which reports after the close today, and EMC (EMC) , which reports before the market opens on Tuesday.

Surveying the Wreckage

Tech stocks took their lumps in very volatile trading last week as

Intel

(INTC) - Get Report

,

Yahoo!

(YHOO)

,

Apple

(AAPL) - Get Report

and

Motorola

(MOT)

disappointed investors. A positive report from

Advanced Micro Devices

(AMD) - Get Report

fueled a semiconductor rebound that left Intel in the dust.

But the Philadelphia Semiconductor Index failed at my monthly resistance at 535.41 for the second time within two weeks. I take that as a sign that the tech sector is vulnerable for a correction. To me, the extent of Thursday's rebound was more of a surprise than Friday's weakness.

And the

Nasdaq

is showing signs of a bust. It traded as high as 2332 on Wednesday, Jan. 11 vs. my quarterly resistance at 2331, fell to 2264 a week later on Jan. 18, then clawed its way back to 2311 last Thursday, Jan. 19. Friday, Jan. 20, it sank to 2248 at the close, below the five-week modified moving average at 2252. Since October, I have been anticipating

Nasdaq 2300 or Bust -- or 2300, Then Bust, and Friday's reversal certainly can be classified as the beginning of a potential bust.

The tech sector is still the cheapest equities sector, at 5.5% undervalued, but this sector was 10.5% undervalued at the end of 2005. At the other end of the spectrum, the sectors that are more than 5% overvalued are basic industries, overvalued by 13.0%, capital goods by 6.3%, consumer nondurables by 7.2%, energy by 14.1%, and public utilities by 7.1%. The fact that so many sectors are overvalued indicates that there are no safe havens in this market, and with tech not as undervalued as in the past, investors need to be cautious with their tech stock selections.

Next to Report

I'll start my look at upcoming earnings with the more anticipated of the two. Chipmaker Texas Instruments is expected to report EPS of 42 cents after the close. The stock has declined from a 52-week high at $34.74 set on Jan. 9 to a low of $31.31 on Friday. With the bar lowered, perhaps Texas Instruments can help the tech sector stabilize.

Texas Instruments is rated a hold by ValuEngine. It's 8.7% undervalued according to my model, with fair value at $34.67, which was tested at TI's high on Jan. 9. The weekly chart profile shows declining momentum, with the five-week modified moving average at $32.61 and the 200-day simple moving average as support at $30.24. According to Thomson/First Call, 27 analysts have a median price target of $36 for Texas Instruments with a high price target at $43, which is a stronger profile than my model yields.

I show risk in Texas Instruments to my quarterly value level at $26.38, where shares would qualify for candidacy in a long-term tech stock portfolio because they'd be a much more impressive 23.9% undervalued at that level. Odds are that Texas Instruments has seen its high for awhile; I show monthly risky levels at $34.98 and $37.09.

Storage and IT company EMC rates a hold for ValuEngine. It also is 44.9% undervalued, judging by my model, with fair value at $24.01. The weekly chart profile shows declining momentum, with the five-week MMA at $13.65 and the 200-week SMA at $11.14. According to Thomson/First Call, 19 analysts show a median price target at $16.50 with a high target at $20. That's a stronger profile than my model shows.

EMC has been trading among quarterly pivots at $13.22 and $13.36 and a monthly pivot at $14.08. The upside on a positive earnings reaction is to my monthly risky level at $14.77. The downside risk is to my semiannual value level at $9.74.

Reviewing the Wounded

Advanced Micro Devices was the only bright spot among the stocks I profiled before their reports last week. Even though ValuEngine rated AMD a sell, I

described the company as a pure momentum play. AMD was not immune to Friday's selloff, however, as shares declined from a new 52-week high set at $38.40 on Jan. 19 to $35.25 on Friday. The downside is to my monthly pivot at $32.52.

Apple was declining off its all-time high of $86.40 set on Jan. 12 as it announced earnings. Guidance was weaker than expected, and it quickly became clear that Apple trees do not grow to the sky. Shares were sliced by 8% from $82.49 on Jan. 18 to Friday's low of $75.83. When I profiled Apple last week, I described the stock as a pure momentum trade. Now there appears to be a correction towards my monthly and quarterly value levels at $72.59 and $68.70, which is still above the stock's fair value at $66.49.

eBay

(EBAY) - Get Report

traded lower in after-market trading in reaction to its earnings, but the powerful market rebound on Thursday erased that loss. Shares traded as high as $47.86 before declining to $44.72 on Friday. I showed a monthly value level at $41.37, which was tested at the after-hours low, and a semiannual risky level at $46.83, which was tested at the Thursday high. This trading range should continue this week.

IBM

(IBM) - Get Report

traded up to $84.70 following its earnings report, but then declined to $81.25 on Friday. The high was below my quarterly pivot at $86.12. There is now risk to my quarterly value level at $79.43, where long-term investors should consider adding to this holding.

Intel lost 14.8%, going from $25.52 to $21.75, last week on weaker-than-expected earnings. The reaction put shares immediately below my monthly pivot at $23.41, which indicates risk to my semiannual value level at $19.66. That's a level where long-term investors should consider adding to this holding.

Motorola was poised to retest its Nov. 23 high at $24.99, trading at $24.35 just before its earnings report last Thursday. Motorola gave disappointing guidance, and shares declined 7.8% Friday to $22.46. Shares immediately traded below quarterly pivots at $24.26 and $24.12 and my annual pivot at $23.11, which indicates risk to my annual value level at $20.96. It's worth noting that that level is still above the stock's fair value at $18.90.

Yahoo! was another big loser following disappointing earnings, with shares losing 17.2%, dropping $40.11 to $33.21. Shares immediately fell below my semiannual value level at $36.94, which is now a risky level. Had shares stayed above $36.94, buyers should have emerged at that level. The fact that they busted right below $36.94 indicates risk to the 52-week low at $30.30.

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).

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.