Traditional bowling involves a “gutter” on each side of the lane. If you throw a bad ball, your ball goes into one of the two gutters.
Bumper bowling eliminates that problem. Bowl a bad ball, and your ball bounces off of a bumper that sits inside of the gutter. A ball thrown too far to the right bounces off the right bumper and heads back to the middle. Visa-versa for the left bumper. If you threw the ball too hard or too early against a bumper, you might get rebounds off of both bumpers as the ball gets bounced back and forth between the two extremes.
Momentum indicators are meant to act like bumper bowling. An overdone stock to one side of the lane (overbought or oversold) pushes the stock back. Same goes for volatility studies like Bollinger Bands. An overbought or oversold stock may run along the “bumper” for a while, as with momentum studies. But eventually, the stock finds its way back to a normalized condition closer to the middle. At least most of the time it does. Such a correction might be likened to a market pullback or oversold bounce from the extremes.
Right now, we have an overbought market on the important weekly chart view. The SPX has been running along its upper Bollinger Band (volatility band) since November 2019. Longer termed momentum via the MACD indicator has been parabolic, as has mid-termed momentum been overbought since November, via a very high RSI level. Stochastics has generally been indicating overbought neartermed conditions ongoingly since early 2019.
Typically, overbought conditions (BB, MACD, RSI, Stochastics) dont last forever. Markets regress to the mean by correcting. However, 2017 proved that markets can remain overbought atypically for long time frames on occasion.
It’s all about the Fed
I might note that what caused markets to return to more volatile times in 2018 was a tightening policy by the US Federal Reserve. I blogged on that development here.
Accommodative Federal policies were reinstated in 2019, and the probability of continued low interest rates remains. So it’s likely that current overbought market conditions will only be corrected by a minor dip. Such a correction may take a while to materialize. Or not. Seasonality can sometimes be a bit soft for the SPX in the second half of January – per the equity clock chart below. I’ve circled that last two weeks of January on the chart. So, perhaps such a dip, should it occur, is in the cards in the next few weeks. As such, we’re up to about 14% in cash in the ValueTrend Equity Platform. We were fully invested just a week ago.