3 Over Extended Stocks Due For Profit Taking

Includes: RAX, SPY, TOL, UAA, UUP
by: Stock Traders Daily

In the odd event that you haven't heard, there is a Fed meeting this week culminating with Chairman Ben Bernanke holding a press conference on Thursday afternoon. All expectations, it seems, based on the stock market's action, is that QE3 will be formally announced that day.

Leading up to this highly-anticipated decision, Mr. Bernanke spoke at the Jackson Hole symposium on August 31 and the FOMC released its minutes from its latest meeting on August 22.

The main takeaway from those two events was that the Fed stands ready to act with another round of monetary stimulus and the market is all-in, betting on a QE announcement on Thursday. Consider that despite lousy economic data, including last Friday's dismal jobs report, and various profit warnings from key large-caps such as FedEX (NYSE:FDX) and Intel (NASDAQ:INTC), the SPDR S&P 500 ETF (NYSEARCA:SPY) is still up about 5% since late July.

So, the question now is, "Is QE3 all but baked into the market?" I believe that it mostly is and that after the initial knee-jerk reaction, the market could be poised for a "sell-the-news" reaction. As noted above, more stimulus has been telegraphed for some time. Similar to a negative overhang finally being lifted from a stock - such as a pending lawsuit being resolved - and then seeing that stock lift higher; the market could experience the inverse. The assumed positive catalyst will be off the board and investors will be left staring at ugly fundamentals.

Furthermore, as I have suggested in other recent articles, one has to wonder whether more stimulus will actually do more harm to the economy than good. Mr. Bernanke certainly won't admit it, but the numbers don't lie. Gas and food prices have shot higher, along with the stock market, and the dollar has lost value, in anticipation of QE3. Just take a look at a chart of PowerShares DB US Dollar Index Bullish (UUP) and one will get a good picture of what has happened to the dollar, and your purchasing power over the past couple of months. The ETF has sunk by over 5% since late July.

As you can probably surmise, I am leaning towards the bearish side in the aftermath of Thursday's Fed meeting. I just don't see how the Fed can surprise to the upside. I also greatly question the effectiveness of another round of stimulus given that household budgets are already strapped due to rising costs at the pump and grocery stores, and stagnant wages. With that in mind, I wanted to identify a few stocks that look over-extended to me, that also have rich valuations. This combination could set up for sharp snap-backs if the market does correct.

One stock that caught my attention is Under Armour Inc (UA), the maker of sports apparel. Shares made all-time highs on September 7, and from a fundamental perspective, there is plenty to like here. The company is coming off a beat-and-raise quarter on July 24, with revenue up an impressive 27% to $369.5 million. Its footwear segment was a clear standout as its new line of running shoes, "UA Spine," was a success.

But, the stock is due for some consolidation. Looking at a monthly chart, the stock has a "parabolic" feel, moving straight up since late 2011 without taking a breath. Its valuation is also exorbitant with a 1-year forward P/E of 38x and a trailing P/S of about 4x. This is well-above its larger peer Nike (NYSE:NKE), which is at 17x and 2x, respectively.

From a technical standpoint, UA does have some support in the $56-$58 area, so traders may want to see how the stock reacts should it test the lower-boundary of that zone. If it breaks below $56, a dive to the lower $50s/upper $40s could be in store.

The next stock I wanted to highlight is Toll Brothers Inc (TOL). Admittedly, I have been a skeptic on the housing recovery, but TOL's recent financial results speak for themselves. On August 22, it reported blowout Q3 figures and provided very bullish commentary on the housing market. Specifically, it said that "We are enjoying the most sustained demand we've experienced in five years …"

The situation in the housing market is not dissimilar to what is occurring in the auto industry. While the macroeconomic situation is still bad, people have been waiting to move (or buy a new car) for the last four or five years. There is a lot of pent-up demand. The question is, is this sustainable given the underlying climate in the housing market and the economy? My feeling is no, it is not, given the massive glut of foreclosures remaining, the still incredibly strict underwriting standards for mortgages, the fact that millions of people remain underwater on their current mortgages, and the labor market remains weak.

But, this pent up demand scenario could play itself out for a few, or several more quarters. What makes me think TOL could be a short right now is that the stock, after surging by 130% over the past year, is coming up on significant resistance at the $34-$36 level. TOL also has a trailing P/E north of 62x. In other words, this stock is due for some significant profit-taking.

The last stock I wanted to discuss is Rackspace Hosting, Inc. (RAX). The stock has been on fire since early August, surging by nearly 50%. Its valuation metrics are off the charts, with a P/E near 100x and the stock is simply due for a breather.

Like the other two stocks mentioned today, its fundamentals look solid right now. The Street is currently forecasting its EPS to grow by 45% and its revenue to jump by 27% next year. RAX is a "cloud play," and its OpenStack cloud service platform has been recently launched and is performing extremely well. So, although RAX has been a very strong stock and its outlook is bright, it is a name that looks prone to some short term profit-taking here. For those looking to get long, I would prefer to wait for a better entry point.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was written by Dennis Hobein, contributor to Stock Traders Daily