In this article, we will discuss the following stocks: Textron Inc. (TXT), JDS Uniphase Corporation (JDSU), PulteGroup, Inc. (PHM), Denbury Resources, Inc. (DNR), Life Technologies Corporation (LIFE), Micron Technology, Inc. (MU) and Advanced Micro Devices, Inc. (AMD).
The seven stocks covered are S&P 500 mid-caps that have run up over 25% year to date and have RSIs of 70 or better. The S&P index as a whole and these seven stocks have reached a frothy, overbought level. The rapid advance has come too far too fast and is on an unsustainable trajectory, leading me to believe the market is setting up for a pullback. There is no doubt in my mind that at the first sign of a trend reversal, institutional and high frequency traders will be caught in a game of "catch-as-catch-can" to lock in profits. The macro state of the market is not the only reason many of these stocks may be heading for a fall. In the following sections I will first lay out my case for the S&P correcting and the overbought condition of these stocks then review each of the stocks fundamentals to surmise what they are telling us.
Extreme Bullishness and Overdone Momentum Equals Red Flag
Positive territory was discovered by the S&P 500 at the end of trading last Friday. The S&P reached its highest level since its prior pull back last summer. The broader markets have risen slightly four sessions in a row corralling a 2.0% gain last week with the third consecutive weekly increase. Then Wednesday, the Fed added fuel to the fire by effectively invoking QE 2.5. The Fed said it won't raise rates until 2015, since its statement said it was holding rates low through 2014. Market expectations were for the Fed to raise rates in mid-2014. This change in stance turned the market from red to green in the blink of an eye.
What a great start for the S&P 500 (SPY); it is up by 5.5% since December 31st. "If the market were to continue on this trajectory we would have a greater than 50% return for the year," said, Todd Morgan of Bel Air Investment Advisors. "This rate of increase is clearly unsustainable." Nevertheless, what makes this point in time so special? Walter Zimmermann of United-ICAP gives us the telling signal.
Walter Zimmermann of United-ICAP, pointed out:
There is too much bullish sentiment coupled with a momentum extreme in the market currently. The combination of extreme bullish sentiment and overdone momentum has only occurred three times in the last 15 years on March of 2000, October 2007, and may of 2011 so there is cause to be concerned. See chart below.
Chart provided by CNBC
Zimmerman and Morgan see a near term pull back of 5% to 10% allowing stocks to consolidate before moving forward and reaching new heights this year. The market has been eerily quiet regarding volatility this year, but I believe things may be about to change as the political rhetoric heats up and the end of earnings season nears. There were noticeable downturns at the end of each earnings seasons last year with traders left with nothing but negative eurozone headlines to trade off.
Company Fundamentals Reviews
JDS Uniphase, Micron and Advanced Micro Devices
Three of the stocks are in the technology sector. JDS Uniphase with a 29.98% performance year to date is the number one best performing tech stock in the group, followed closely by Micron at 24.96% and AMD at 24.63%. Unfortunately that has left them in a frothy overbought state with relative strength index readings of 78.11, 71.44 and 79.54, respectively. A stock is usually considered overbought when the relative strength index reaches above 70. All seven of the stocks in this article have RSIs of 70 or better.
The Relative Strength Index was developed by J. Welles Wilder and published in a 1978 book, New Concepts in Technical Trading Systems, and has become one of the most popular oscillator indices, according to Wikipedia. Wilder posited that when price moves up very rapidly, at some point it is considered overbought. Likewise, when price falls very rapidly, at some point it is considered oversold, in either case, Wilder deemed a reaction or reversal imminent. Wilder believed that tops and bottoms are indicated when RSI goes above 70 or drops below 30. Traditionally, RSI readings greater than the 70 level are considered to be in overbought territory, and RSI readings lower than the 30 level are considered to be in oversold territory. In between the 30 and 70 level is considered neutral, with the 50 level a sign of no trend.
Textron Inc. operates in the aircraft, defense, automobile, industrial and finance businesses worldwide. Textron Inc. just reported fourth quarter results and raised 2012 guidance, causing a 14% one day gain in the stock Wednesday. Textron is forecasting 2012 revenues of approximately $12.5 billion, up about 11%. Earnings per share from continuing operations are expected to be in the range of $1.80 to $2.00. Cash flow from continuing operations of the manufacturing group before pension contributions is estimated to be between $700 and $750 million with planned pension contributions of about $200 million. This has led it to a current 2012 gain of 33.91%. Nevertheless, along with this incredible gain comes an incredibly overbought condition. Agilent currently has a relative strength index rating of 84.67, extremely overbought.
PulteGroup, Denbury and Life Technologies
PulteGroup was down significantly for the year in 2011 and is currently in third place among these stocks for 2012 with a one month gain of 26.62%. PulteGroup is a great company with excellent fundamentals with a Price to Sales ratio of 0.75 and an EPS estimate of 140% for next year. Nonetheless, currently it has a RSI reading of 68.12 which is a red flag that it is about to cross the overbought rubicon.
In the market, as in life, timing is everything. Identifying and capitalizing on these nuances separates the good from the great investors. Cummins will trod forward and will mostly likely be up in a year from now, but the savvy well informed investors paying attention to all the key indicators will be vastly ahead of the people who buy and simply hope based on an overarching belief.
Denbury and Life Technologies fill out the top seven 2012 winners list, although this outperformance may be more related to a phenomenon known as the January effect than any underlying fundamentals. These stocks have seen gains of 26.49% and 26.16% in 2012 respectively after having lackluster 2011 performances.
The January effect is the most common theory explaining this phenomenon. Individual investors, who are income tax-sensitive, sell stocks for tax reasons at year-end (such as to claim a capital loss) and reinvest after the first of the year. Another cause is the payment of year-end bonuses in January. Some of this bonus money is used to purchase stocks, driving up prices.
With RSI's of 72.59 and 74.92, respectively, these stocks appear ripe for a pullback just as all the other stocks covered in this article. What's more, with the global debt debacle causing many countries to implement austerity packages rather than stimulus packages, the global growth prospects seem jeopardized. Nevertheless is only half of the equation, we need to review the fundamentals of these companies to see if the uptick in price was justified. We will now review the underlying fundamentals to discern the strength of these companies.
Fundamental Statistics Table (Click to enlarge)
Table Provided by Finviz.com
Textron has a PEG ratio of 0.42, a forward Price to Earnings ratio of 14.83 and a projected EPS growth rate of 45.72% for next year. Textron is 14% below its 52 week high. These fundamentals are strong. A PEG of less than 1 is extremely bullish. This fact coupled with strong EPS growth and reasonable price performance confirms that although Textron's short-term technical indicators are flashing red; its long term prospects for future price appreciation are good. Textron is severely undervalued.
JDS Uniphase has a PEG ratio of 4.51, a forward Price to Earnings ratio of 14.91 and a projected EPS growth rate of 42.19% for next year. JDS Uniphase is 53% below its 52 week high. A PEG of 4.51 is extremely bearish. It indicates that although JDSU has good projected EPS, the growth is overpriced and overvalued.
PulteGroup is a great company with excellent fundamentals with a Price to Sales ratio of 0.75 and an EPS estimate of 140% for next year. PulteGroup is 6% below its 52 week high. PulteGroup is extremely undervalued at this level.
Denbury has a PEG ratio of 0.67, a forward Price to Earnings ratio of 14.04 and a projected EPS growth rate of 3% for next year. Denbury is 27% below its 52 week high. Although EPS growth looks weak for next year, this is priced in to the stock based on the PEG ratio being less than one. Denbury is undervalued at this level.
Life Tech has a PEG ratio of 2.91, a forward Price to Earnings ratio of 12.06 and a projected EPS growth rate of 9.7% for next year. Life tech is 14% below its 52 week high. The PEG ratio is indicating Life may be priced expensively for the projected growth rate and may be overvalued.
Micron has a forward Price to Earnings ratio of 20.68 and a projected EPS growth rate of 202.70% for next year. Life tech is 34% below its 52 week high. Micron is significantly undervalued at these levels.
AMD has a PEG ratio of 0.676, a forward Price to Earnings ratio of 11.41 and a projected EPS growth rate of 25.53% for next year. AMD is 30% below its 52 week high. AMD's fundamental are indicating it is undervalued at current levels.
Although the market looks frothy and set for a pull back, I would use the as a buy on the dip opportunity for the majority of these stocks that are undervalued by their fundamentals and dollar coast average down.
JDSU and Life Technologies appear overvalued at current levels. I would take profits on the current run up and wait for a lower re-entry point.
Use this information as a starting point for your own due diligence and research methods.