Downgrades Challenge Dow Theory Buy

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NEW YORK ( TheStreet) -- As the Dow Industrial Average and Dow Transportation Average set new all-time highs, nine components in the Dow 30 and four transportation stocks have been downgraded to hold from buy this week. These downgrades are significant and threaten the underpinnings of the stock market and the sustainability of the Dow Theory Buy signal confirmed on Tuesday.

At www.ValuEngine.com, we continue to show that stocks are fundamentally overvalued, with 61.6% of all stocks overvalued, 15 of 16 sectors overvalued, and 10 overvalued by double-digit percentages.

These 13 downgrades represent stocks in six overvalued sectors. Aerospace is overvalued by 6.8%; computer & technology by 14.8%; consumer discretionary by 9.2%; finance by 17.1%; oils-energy by 4.3%; and transportation by 19.2%. The finance stock downgraded is one of the four "too big to fail" money center banks.

As the major equity averages move higher, their weekly chart profiles become even more overbought technically. The 12x3x3 weekly slow stochastic readings are 93.16 for Dow Industrials and 94.27 for Dow Transports. (Readings above 80.00 are overbought on a scale of 00.00 to 100.00.)

Dow Theory confirmed a buy this week with Dow Industrials and Dow Transportation setting new all-time closing highs on Wednesday and Tuesday, at 14,296.24 and 6,136.72, respectively. The intraday all-time highs were set on Wednesday at 14,320.6 and 6188.58, versus my semiannual and weekly risky levels at 14,323 and 14,387 Dow Industrials and my weekly risky level at 6192 Dow Transports.

Before this week, 24 of 30 Dow components were rated buy according to ValuEngine, and today this underpinning is down to 15 of 30. In the Transportation Average, the underpinnings are even weaker with only five of 20 stocks rated buy down from nine of 20.

When key stocks lose their buy ratings, they become momentum trades which results in a new twist to my "buy and trade" strategy.

The strategy to reduce positions on strength to risky levels remains in play.

But with weaker underpinnings you may want to consider employing a sell stop on a close below a value level instead of buying weakness to a value level for stocks not rated buy.

An alternate exit strategy when trading stocks without a buy rating is to employ a sell stop on a weekly close below a stock's five-week modified moving average (MMA).

Reading the Table

OV / UN Valued : The stocks with a red number are undervalued by this percentage. Those with a black number are overvalued by that percentage according to ValuEngine.

VE Rating : A "1-Engine" rating is a Strong Sell, a "2-Engine" rating is a Sell, a "3-Engine" rating is a Hold, a "4-Engine" rating is a Buy and a "5-Engine" rating is a Strong Buy.