MARKET OVERVIEW

At the beginning of this year we wrote that we expected 2014 to be flat for the market as a whole, and one-quarter of the way through the year that prediction is right on the money. Going into today – the last trading day of the first quarter – the tech-heavy NASDAQ Composite Index was twelve points higher than it closed on the first trading day of the quarter, for a net gain of only 0.3%.

The Dow Jones Industrial Average is down slightly, off 118 points for a drop of 0.07%.  Thus far the S&P500 is the “big winner”, up 25 points for a gain of 1.4%.  In other words, if you have a diversified stock portfolio of large and mid-cap U.S. stocks then you are probably right about at breakeven for the year.

We also said at the start of this year that although it should be flat for the market as a whole it would be a “two-tier” market for tech stocks with an equal number of winners and losers, and thus far our portfolio performance is proving that out.

If you had put an equal amount of money in our ten Investments Portfolio stocks at the beginning of this quarter, your overall return going into today would be 3.38%, or ten times the performance of the NASDAQ Composite Index, and more than the double the S&P500 Index!

And therein lays the secret to successful stock market investing in 2014: you not only need to be diversified, but more importantly you also need to avoid the overpriced tech stocks that can drag down your portfolio returns. Some of 2013’s hottest stocks are paying the price in 2014, such as Equity Trades Portfolio short-sell recommendation Amazon.com (NSDQ: AMZN) down 15% year-to-date, recently closed Equity Trades Portfolio short-sell recommendation 3D Systems (NSDQ: DDD) down 37%, and recent IPO Twitter (NSDQ: TWTR) shedding $20 in value this year for a loss of just under 30%.

You only need one or two “portfolio bombs” like these to undermine the rest of your portfolio. That’s why we created our Smart Tech Rating, as it acts as an early warning system to identify stocks that have become grossly overvalued.  For example, if you look at the Smart Tech 50 listing under the Portfolios tab, you can click on the STR column to view all fifty of the stocks we cover to see how they rank.

Right now, the tech stocks with the lowest STR scores – and therefore the most at risk of a major decline – are as follows:

Netlix (NSDQ: NFLX); STR = 0.3

Twitter (NSDQ: TWTR); STR = 0.3

YELP (NSDQ: YELP); STR = 0.3

Amazon.com (NSDQ: AMXN); STR = 0.6

Digimarc (NSDQ: DMRC); STR = 0.7

Salesforce.com (NSDQ: CRM); STR = 0.8

Those are all the stocks with an STR below 1.0 at the moment.  By way of comparison, our highest scoring stock (Ricoh) has an STR of 12.4, and the average STR for all fifty stocks is 4.658. We believe you should only consider buying stocks with an STR at least 50% above the average score, which currently works out to 6.99.  Right now there are ten stocks with an STR above that level, all of which are included in one of our recommended portfolios.

And if you are looking to capitalize off of negative volatility, we only recommend selling short and/or buying puts on stocks with an STR at least 50% below the average score, which currently works outs to 2.33. At the moment there are thirteen stocks in our coverage universe that fall below that level.

[If you have questions regarding the STR rating system, please comment in the Stock Talk section below this article and we will be happy to clarify]

In the long run the stock market is a ruthlessly efficient arbiter or value, rewarding companies that do well while severely punishing those that do not. It can get fooled in the short run, but eventually it figures out the truth and metes our justice with a firm hand. We believe 2014 will be a year where justice is administered in stern doses in both directions, so construct your portfolios accordingly.

As the old saying goes, What goes around – comes around.

NASDAQ Composite Index:

Friday, March 28 = 4,155.76

Year to Date = + 0.3%

Trailing 7 Days = – 2.9%

Trailing 4 Weeks = – 4.4%

PORTFOLIO UPDATE

Most of our portfolio recommendations are trading within their defined parameters, so I want to take a moment to discuss our current short sell recommendation for Amazon.com (NSDQ: AMZN), as we believe it is in the early stages of a long term decline.

The reason we believe Amazon still has much further to fall is that the business for which it is best known and generates the vast majority of its revenue – online retailing – continues to experience narrowing margins to the point of becoming commoditized. Meanwhile, the Amazon business unit that offers the most long term profit potential in our opinion – Amazon Web Services (AWS) – is still in its nascent stage and cannot accurately be predicted.

Meanwhile, the stock pays no dividend and trades at 175 times forward earnings, compared to a multiple of 24 times forward earnings for its peer group. Needless to say that discrepancy reflects enormous growth expectation in earnings several years down the road, which may or may not materialize.

So what is a fair price for Amazon’s stock? Although its value has already dropped more than 15 after cresting above $400 late last year, we think it could drop all the way down to at least $250, possibly as low as $200 (and if that price sounds crazy to you, even at a price of $200 the stock would still be trading at almost 100 times forward earnings).

Our original recommendation was to sell short Amazon.com above $390, but we feel comfortable reducing that limit price to $325 for those of you who have not yet had a chance to make a play on Amazon. Sooner or later the market is going to demand greater profitability from Amazon, and right now the company cannot deliver it.

Amazon.com (NSDQ: AMZN) is a short-sell recommendation in our Equity Trades Portfolio above $325.