Yes it is illegal and this will eventually catch up with her. The copyright and trademark owners have their hands full enforcing their rights against infringers and it may take a while before they act
Interesting scenario; using someone else's copyright work embedded into a piece of jewelry.
She paid for the work originally, did not make any copies, so in my opinion there is no copyright infringement under the "first sale doctrine." (But note: there is a split between the 7th and 9th circuits on similar facts. 7th circuit ruled that someone placing another's postcards onto ceramic tiles and coating with a clear varnish and then selling these tiles was not committing copyright infringement 9th circuit in similar case ruled the opposite.
Now... trademark is different. If there is any "likelihood of confusion" by the consumers as to the source of the goods, then there would be trademark infringement. Advertising using DC, Disney, Marvel may (or may not) lead to consumers believing her product is somehow made by/sponsored by DC, Disney, Marvel, etc. Although not copyright infringement as they are not a "copy" because you said she actually cut them out from a comic book and did not illegally make copies of those images to use again and again, it could be trademark infringement; if the consumer somehow thought or was led to believe that Disney had produced or sponsored the production of the product.
My guess is that while she may be dancing close to the fie, either:
A) she is so insignificant Disney could not be bothered,
B) She is so good in her jewelry designs that Disney is impressed and happy to have people wearing their characters cut from a comic book and put into a nice piece of jewelry,
or my most likely guess C) she may be close, but not over the edge and Disney feels it would be a losing battle (both publicly and legally speaking) to bring a trademark infringement suit against her. i.e. How many consumers would believe that the jewelry was produced or sponsored by Disney and not know that the jewelry artist herself cut out the images from comic books and embedded them into her jewelry.
One other concern could be her use of these brand names in her advertising, but if factual, not misleading, maybe with disclaimers, she is likely fine there also.
Thus, the ultimate answer to your question of it being illegal actually depends on whether her business is in the 7th or 9th circuit's jurisdiction.
My disclaimer is simply that Avvo already has an adequate disclaimer.
Yes, as noted by my colleagues, her conduct is unlawful -- and by offering her infringing works for sale the retail stores are also engaging in unlawful conduct. But can you use the law to stop her? Maybe. Speak with your own intellectual property attorney about potentially bringing an unfair competition and/or false advertising action. Whether you can or not will depend on whether there are sufficient facts for you to have "standing" to sue. Because you compete with her for business both of the claims mentioned may be viable. Of course you'd have to weigh the potential upside of filing suit against its cost -- which quite likely makes pursuing her via a court action not worth your time or money.
The above is general information ONLY and is not legal advice, does not form an attorney-client relationship, and should NOT be relied upon to take or refrain from taking any action. I am not your attorney. You should seek the advice of competent counsel before taking any action related to your inquiry.
Yes, likely illegal under copyright law as a derivative work and under trademark law as infringing and unfair competition. The copyright owners go after things that cost them revenue and usually let small fads go. If she keeps this up, sooner or later one of the big dogs you mention will bite her. If she is damaging you, you might see an IP attorney to determine if an unfair competition suit makes economic sense. I predict it will not, but that will be your call.
I am not your lawyer and you are not my client. Free advice here is without recourse and any reliance thereupon is at your sole risk. This is done without compensation as a free public service. I am licensed in IL, MO, TX and I am a Reg. Pat. Atty. so advice in any other jurisdiction is strictly general advice and should be confirmed with an attorney licensed in that jurisdiction.