Be Wary of Excessive Speculation

By Ken Shreve,

Shutterstock photo

As major averages continue to move higher at a snail's pace, the calls for a market pullback seem to have subsided a bit.

The bears' case isn't a bad one by any means, but sell signals -- for now -- remain few and far between. Headed into Wednesday, the S&P 500 showed just two higher-volume declines in recent weeks -- nowhere near enough to cause problems for an uptrend. Market-leading growth stocks are holding up just fine. Very few are showing signs of institutional selling, threatening to break below key support levels.

One other thing to look for near a market top is excessive speculation in lower-quality names. The thinking here is that once all the high-quality stocks have moved (and a lot of them have moved already), the only thing left is the lower-quality names. Once the lower-quality names have moved, there aren't any more buyers left, raising the odds of a market pullback.

The restaurant group is a good example. While former leaders like Panera Bread (Nasdaq: PNRA ) and Chipotle Mexican Grill (NYSE: CMG ) continue to struggle, many speculative, sub-$1 billion market capitalization names in the group have started to move.

On Tuesday, Red Robin Gourmet Burgers (Nasdaq: RRGB ) reported a blowout quarter and investors responded positively, sending shares higher by 19%. After several quarters in a row of single-digit sales growth, sales jumped 17% to $240.7 million. Short interest was high in Red Robin ahead of earnings so a big part of Tuesday's move was most likely short covering. It was an outstanding report, but with a market capitalization of $617 million, Red Robin is one of the more speculative names in the group.

Other spec restaurant names on the move lately include Del Frisco's Restaurant (Nasdaq: DFRG ), with a market capitalization of $417 million, Nathan's Famous (Nasdaq: NATH ) with a market cap of $171 million and Ruth's Hospitality (Nasdaq: RUTH ) with a market cap of $325 million.

Meanwhile, the IPO market has gotten a little frothy as well. Xoom (Nasdaq: XOOM ), a provider of online and mobile money transfer services priced at $16 on Feb. 15 and closed at $25.49, up 59%. And ExOne (Nasdaq: XONE ), a provider of 3-D printing services, went public on February 17 at $18. It closed at $26.52, up 47%.

Keep in mind that excessive speculation in less liquid names doesn't automatically mean a market pullback is nigh. But it's happening now, and when you see it alongside a big crop of extended stocks out there, it raises the odds of a market pullback. If you're holding on to some winners, it's OK to give them more room to work. Just recognize that yellow flags are out there.

(c) 2013 Benzinga does not provide investment advice. All rights reserved.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing Investing Ideas
Referenced Stocks: CMG , NATH , PNRA , RRGB , RUTH

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