One sign that the market is overbought

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.

Conclusion

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.

Of note

Readers have been asking me to arrange something that will automatically deliver the blogs to their email to avoid missing the new ones. Well, I finally arranged to make this happen! Use the “never miss another blog post” button on this page