There are growing signs that the major NA indices are becoming quite overbought. Before I go on to offer some evidence to this potential, recall that the market is quite skewed in its valuations and technical momentum. Lots of extremes in this market – overbought and oversold. I have blogged on the “barbell” concept of this market many times, including here. What this means is that there will be stocks that are hit harder than others if/as/when a correction occurs.
Many regular readers of this blog will be aware of my rule of thumb surrounding how far a security or index is over its 200 day SMA (Simple moving average). My rule of thumb is to start watching a stock or index if it gets more than 10% over its 200 day SMA. A move of 15% over that average is starting to look serious. The chart below notes various occasions where the market moved more than 10% above or below its 200 day (40 week) SMA. Note that its a decent predictor of corrections or market bottoms. The one time on this chart we didn’t get a clear sell signal from the indicator was at the end of 2018, when the market was only ahead of the SMA by about 6% before the strong correction occurred in December. Otherwise, its been bang-on over the period shown.
Right now the SPX is about 13% over the SMA. This does not imply an immediate correction, but it does imply a high likelihood of some sort of pullback is imminent. Because the trend remains bullish, I would suggest that such a pullback would be a buying opportunity.
The market itself can also indicate an overbought or oversold status by the % of stocks that are currently trading above their 200 day moving average. Here is a chart of that indictor. Its clear that we have an unusually high number of stocks trading at high levels. Again, a sign of a likely pullback. Not a stock market crash.
Seasonal cycles and the technical profile argue for a continued bull market. But its an overbought market by many extremes. When markets are so far over their 200 day SMA’s, we typically see a retreat to near that moving average – or just above it. Note the top chart for examples. As such, it may not be too surprising to see a test of 3500-3700 on the SPX. Buying quality stocks that are NOT the crazy overvalued candidates makes sense on a pullback. I am not lightening positions, given our concentration in commodities and value. But we hold a little cash to see if we might find an opportunity or two in the likelihood of a corrective move. Perhaps you should too.
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