Proceed With Caution

 | Mar 06, 2012 | 1:00 PM EST  | Comments
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Stock quotes in this article:

all

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met

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cinf

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bwld

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cbrl

I watched the first Orioles spring training game last night with high hopes and low expectations. I don't watch many spring training games, but it was nice to have baseball on TV again. While I watched the comedy of errors disguised as baseball unfold, I made the usual round of calls and emails to associates, traders, rogues and roustabouts to get their views on the world. One of my most valuable tools is a great rolodex of people who are smart and don't necessarily think the same way I do. Seeking out other approaches and points of view helps me test my own conclusions and find overlooked opportunities.

Once again, my more technically and statistically oriented friends are beating the bear drums. They use different approaches, indicators and systems, but universally they think there may be bumpy travel ahead. The strong consensus sent me to my chart books to check the few indicators I use to determine risk levels in the stock market to see if there was something that might challenge my do-nothing stance of the past few months.

The long-term charts are reaching overbought levels that tend to make me nervous. They are not at all-time highs, but are at a level where market momentum has started to fade in past rallies. My intermediate indicator is above levels where markets began to sell of last February and again in May and August.

I'm not a trader, so the overbought state of the market is not going to send me rushing to sell stocks or go short. But it is going to make me to check my portfolio for stocks that are overvalued and flash a red light on new purchases. The overbought levels are confirmed by the very short list of cheap stocks my screens have targeted the past few weeks.

I decided to dig a bit deeper and look for sectors and groups nearing overbought levels that previously indicated a top approaching. One of the more overbought groups is one I really like in the long term, but insurance stocks have had a great three-month run and it's time to hold off adding at these levels. Insurance stock indicators are at levels last seen in late 2010, before selling off steeply for almost nine months. The big names in the group, Allstate (ALL) and MetLife (MET), have staged significant rallies the past few months but I would not be a buyer at these levels. Even my cheap favorite, Cincinnati Financial (CINF), is up almost 50% off its lows and has gained about 15% year to date. I would hold off on buying new insurance stocks and consider selling any trading at more than 1.5x tangible book value.

Restaurant stocks are also at overbought levels where they have topped in the past. I have not bought into the restaurant recovery story because the group has dangerously flawed fundamentals that have been ignored by traders. The majority of restaurant reports I have read the past two years have featured slow same-store sales and higher margins from cost cutting. Although my friends have told me business is better, none of them described it as good. Weekend sales are good, but mid-week sales are still slow. There have been a few bright spots in the group, but most of what I have seen from the group is profiting through cost reduction. Now there is nothing left to cut and I can't help but think that rising gasoline prices are going to hurt the industry, especially casual dining. The group has been very strong in 2012, but it is time for caution. If the strength does not fade soon, I will revisit my two favorite shorts in the group, Buffalo Wild Wings (BWLD) and Cracker Barrel (CBRL).

I'm not a market technician and I don't play one on TV; however, I track several indicators that have proven to be reliable for decades, and they indicate caution. Together with the bearishness of my talented technical friends' and the overbought readings I see, it's time to flash the caution sign.

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