I’ve beaten the subject of an overbought market to death lately, so no need to rehash on my mid to long termed chart observations. Visit this blog or this blog or this blog to get a clear picture of what I believe might be the longer termed picture.
Today, I’d like to look at the real nitty gritty stuff. We’ll start with a basic candlestick formation that the S&P 500 has been showing over the past few trading days. The spinning top is a formation signalling confusion in the market. High wicks with a small body in the middle tell us that market participants were excited and buying at one point during the day, then scared and selling during another point of the day, but ultimately decided to close the day pretty close to its opening price. Big emotional swings create tall wicks and long tails.
Note on the chart below the high and lows of January 24th in particular. This is a classic spinning top. The 23rd and 25th were also small bodied days, but did not truly look like spinning tops. Nonetheless, you can see the confusion of late via these candlesticks. If the market puts in a classic reversal candle such as a “hammer” or inverted hammer (which is very powerful as a market top signal), or something like an “engulfing pattern” or an “evening star” (also known as an island reversal)- we could see a neartermed pullback for the S&P 500. Please read my book Sideways for the basics on these and other candlestick patterns.
Now, let’s look at the S&P 500 vs. the 200 day SMA (simple moving average). As of Friday, it was 12.5% over the 200 day SMA. I have done studies on the markets when they are 10% or more above their 200 day (40 week) SMA’s. The net result is that market tend to consistently retract to a point of less than 10% above the 200 day SMA if they remain over that level for any period of time. This retraction to a sub-10% 200 day SMA level can occur via a sideways action, or a correction. The current level of the market vs. this key MA suggests a retraction is eminent.
Finally, let’s look at my short termed timing system. This system employs Bollinger Bands, stochastics, and RSI to measure if the market is likely to pullback or rise. The indicators must trigger overbought or oversold conditions concurrently to issue a buy or sell signal. For the latter half of last year and into this year, we have witnessed a condition of perpetual overbought markets. So my short termed timing system was of no benefit in catching swings. In fact, there have been no swings for the better part of a year.
Having said that, we might look at the conditions on this short termed timing system now. Will the perpetual motion machine that has been the market take a breather?
Note on the short termed timing chart that the levels of RSI and stochastics are particularly stretched right now. They’re exceedingly higher than they were last year. This makes sense, given the parabolic jump the market has taken of late. Despite the market’s ability to brush off the overbought conditions of last year, it is likely that the current mega-overbought conditions are unsustainable.
In a nutshell, we have some candlestick formations that are signalling a change in market psychology. We have a market that is stretched over its 200 day SMA that has historically never held for too long. And we have some short termed indicators that suggest markets are vastly overbought.
All in, I’d bet that we are due for a healthy, much needed neartermed correction very soon.
You might not get the timing dead on but yes a pull back is coming. On a monthly chart this month looks like a blowoff month with a long candle (longer than many previous month’s) and so far above the 20 month moving average. There may even be a slight move higher in Feb but a correction is imminent
Hi Keith, thanks for that analysis. I have two questions: in situations like these, do you rotate into other sectors until the correction is over or do you just go to cash? And second, would you expect oil stocks to also be dragged down?
Looks like my timing was ok on this blog–as we appear to have started the suggested pullback. We are 15% cash and have rotated into a few sectors that may be less affected by a correction–specifically: consumer staples–plus we have a few stocks that we believe have been overlooked, thus likely rotational candidates as the market sells f the overvalued stuff
But overall, we might expect most sectors to be affected negatively–and oil does appear so far to be selling off with the rest
Do you think US Financials have run their course or is there still more upside?
Dave–I am bullish on the US banks specifically and think they have plenty of upside potential. The insurance side of the financials is more of a spotty side to that sector, given their random/sideways patterns in several of the names. Probably due to west coast fire risks etc. So I am focused strictly on the banks, big and small – per this blog: https://www.valuetrend.ca/regional-banks-may-next-jump/
Any guess as to how far we can correct on say the S&P?
That’s the question of the day, isn’t it?
I’ll guess 2700 based on some support in that area. But I will be paying more attention to the RSI line—often a correction within a bull trend (which I assume this is…) will see RSI return to the upper middle of its range–RSI is too high on both daily and weekly charts, but I’d guess that a return on the weekly chart of 14-week RSI to about 60-ish might bring the S&P as low as 2500 if it falls in a straight line. So, depends on whether the market stops at say 2700 and treads water (which would allow RSI to settle down) or if it moves violently down to eliminate the overbought conditions. I’ll blog on this for Wednesday..stay tuned…
At this time of year does the rrsp season not spur on a buying trend which will keep things going until the end of Feb.
RRSP season does usualy help the TSX (and a bit of upside pressure on american exchanges) and 401k season helps the US side
look for upside into late Feb and March as the money gets deployed.
Neartermed action over the coming days–if markets do carry on and correct further– will not affect those tendencies