How Concerning Is An “Overbought” Reading On Weekly RSI?

February 21, 2017

Stocks Are “Overbought” In 2017

On February 17th the S&P 500’s weekly RSI reading closed above 70, which may appear to be a red flag for the stock market based on common terms associated with RSI. From stockcharts.com:

“Developed J. Welles Wilder, the Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. RSI oscillates between zero and 100. Traditionally, and according to Wilder, RSI is considered overbought when above 70 and oversold when below 30.”

Stocks Were “Overbought” In 2014

We can find numerous examples in history when the S&P 500 struggled after weekly RSI approaches 69-to-70 (overbought), including the 2014-2016 example below.

In this post, we will address one question and one question only:

“Is it in the realm of historical possibility for overbought markets to remain overbought for long periods of time while posting impressive gains and avoiding significant pullbacks?”

Is An “Overbought” Reading A Showstopper?

There are numerous examples from history when positive trends in stocks were not derailed after weekly RSI approached 69-to-70. The early 1980s were marked by strong bullish trends. When trends are strong, the S&P 500 can continue to rise for some time after weekly RSI nears “overbought” status. As shown in the chart below, after high weekly RSI readings in 1982, the S&P 500 gained an additional 27% before experiencing a significant pullback.

Stocks Continued To Rise In 1985

While stocks did stall for a time, no significant trend derailment occurred after weekly RSI neared 70 early in 1985; instead, stocks tacked on an additional gain of 84%.

High RSI Readings Were Not Bearish Late In 1985

If we decided to play it safe in October 1985 due to weekly RSI readings approaching “overbought” territory, we would have missed a strong trend that resulted in additional gains of 73%.

Another Chance In 1986

After a pullback in early 1986, another “overbought” decision had to be made as weekly RSI raced back above 70. Instead of killing the rally, it continued for quite some time.

Strong Trend Blows Through RSI 70

An “overbought” market can remain overbought for some time before bad things happen. In early 1987, a push above 70 on weekly RSI signaled a strong market that was ready to rally for an additional eight months, telling us that weekly RSI can be difficult to use as a timing tool.

Waiting For A Pullback

When bullish conviction outpaces bearish conviction, waiting for an “overbought” market to pull back can be a frustrating experience. In 1991, as weekly RSI hung around the 69-to-70 range, stocks consolidated, but never pulled back in a significant manner before eventually posting additional gains of 30%.

A Pause, Rather Than A Correction

Weekly RSI readings in the high 60s were not followed by a prolonged correction in late 1992.

RSI 70 Can Be A Positive After Consolidation

After stocks remained in a trading range in 1993-1994, rather than raising warning flags, a weekly RSI reading above 70 helped usher in a new and sustained trend following the breakout from the orange box below. The 1993-1995 case is also covered in this week’s video below. Regardless of what happens in 2017, if an “overbought” RSI reading can be followed by a 214% gain, it is easy to understand why it is difficult to classify it as a showstopper for stocks.

What Can We Learn From Similar Periods In History?

This week’s video looks at three historical periods that shared similar set-ups to February 2017, allowing us to gain some insight into how stocks may perform between now and December 31, 2017.

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Consolidation, A Breakout, And A New Bullish Trend

Calendar year 1996 also experienced a breakout from a consolidation box, a weekly RSI reading above 70, and significant and lasting gains in the S&P 500.

Another Breakout In 1997

Weekly RSI readings did not spell doom for the bullish breakout that occurred in the spring of 1997; instead, the S&P 500 rallied an additional 83%.

Stocks Rise Following RSI Readings In High 60s

Weekly RSI could not crack the 70 threshold in 1999, telling us bullish trends were starting to wane. However, even as the trend was losing some steam, the S&P was able to push higher into calendar year 2000.

High RSI Following A Breakout

2006 represents another example of consolidation, a bullish breakout, weekly RSI readings near the 69-to-70 range, and a stock market that pushed higher.

One Purpose

In February 2017, weekly RSI is once again in “overbought” territory. The charts above were presented for one purpose and one purpose only:

“Is it in the realm of historical possibility for overbought markets to remain overbought for long periods of time while posting impressive gains and avoiding significant pullbacks?”

Are Major Stock Corrections Coming In 2017?

February 17, 2017

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Is Market Breadth Waving Bearish Flags?

February 13, 2017

All things being equal, during a healthy rally, we prefer to see a high number of stocks participate in the move (strong market breadth). In recent weeks, you may have come across something similar to the MarketWatch headline below:

Market breadth can be tracked in numerous ways. One of the most logical is to compare the health of narrow indexes, such as the Dow which contains only 30 stocks, to broader indexes, such as the NYSE Composite, which contains over 1,900 stocks.

Breadth Before 10% Plunge In Stocks

As described in this week’s video in detail, the S&P 500 experienced a waterfall decline of over 10% following the close on August 18, 2015. Notice in the chart below how vulnerable the trends were in the broad NYSE Composite Stock Index before the S&P 500’s big drop.

How Does The Same Chart Look Today?

The answer to the question above is “much better”. Instead of the moving averages making a series of lower highs and lower lows, the 2017 version of the same chart looks much healthier (see below). Recent gains have been much more broad-based than what transpired in the spring and summer of 2015.

Similarities And Differences: 2015 vs. 2017

This week’s stock market video covers some potentially troubling similarities in the area of sentiment between August 2015 and February 2017. The video answers the question…how concerning is this piece of evidence?

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Additional Measure Of Market Breadth

The 200-day moving average provides a guidepost for long-term trends. All things being equal, we prefer to see a stock or ETF above their 200-day moving average. Just prior to the 10% plunge in August 2015, only 41% of the 1,900 stocks in the NYSE Composite were above their 200-day moving average. Contrast the weak state of long-term trends in 2015 to the present day (1st chart vs. 2nd chart below).

How Likely Is A Plunge Similar To August 2015?

February 10, 2017

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Are The World’s Greatest Value Investors Bearish?

February 6, 2017

Actions Speak Louder Than Words

If you want to know what someone really thinks about the stock market, look at their recent portfolio transactions. What can we learn from recent moves made by two of the world’s most respected value investors?

Buffett Loaded Up After U.S. Election

With a focus on intrinsic value, based on future earnings potential, Warren Buffett has compiled one of the best track records in investing history. Buffett’s portfolio includes common stocks, such as Wells Fargo (WFC), Coca Cola (KO), International Business Machines (IBM), Apple (AAPL), and General Motors (GM). Therefore, if Buffett thought the stock market was currently significantly overvalued, we would expect him to be a net-seller in recent months. From Reuters:

Buffett revealed that he has bought $12 billion of stock for his company Berkshire Hathaway Inc. since the Republican Donald Trump beat Democrat Hillary Clinton in the Nov. 8 U.S. presidential election. In an interview with talk show host Charlie Rose that aired on Friday night, Buffett suggested that Berkshire’s post-election stock purchases overall were even higher, reflecting stocks that his deputies Todd Combs and Ted Weschler bought. “We’ve, net, bought $12 billion of common stocks since the election,” Buffett said. “The guys that work with me, the two fellows, they probably bought a little bit or sold a little bit too.” The speed with which Berkshire is buying stocks is unusual.

Do The Charts Agree With Warren Buffett?

This week’s stock market video asks three common sense questions about the long-term sustainability of the stock market rally. The answers are based on facts in hand, rather than opinions or forecasts.

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Is Bill Miller Concerned About Stocks?

Bill Miller’s fund beat the S&P 500 for 15 consecutive years from 1991 through 2005. Like Buffett, Miller unquestionably understands how to value common stocks. Has Miller been unloading shares in recent months? From a February 2 CNBC article:

“The stock market is not terribly expensive, and the market has a tailwind,” Miller said. “As long as the economy is growing and earnings are growing, the market is well underpinned.” Miller said he was fully invested in the stock market before the election and remains so.

How Helpful Are Valuations?

Reviewing PE ratios on the chart below in isolation, it would be easy to draw a conclusion that runs counter to the statements from Warren Buffett and Bill Miller above.

A detailed January 2017 analysis expands the sample size allowing us to examine PE ratios from a more balanced and broader perspective; the results may surprise you. It is important to note, Buffett and Miller have a long-term focus; their views tell us little about the market’s short-term outlook.

Three Questions About Rally’s Sustainability

February 3, 2017

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Stocks: The View From 30,000 Feet

January 30, 2017

Taking A Big Step Back

Uncertainties created by President Trump’s curbs on travel and immigration contributed to a selloff in stocks Monday. The monthly S&P 500 chart below allows us to filter out some of the day-to-day volatility. As of this writing, three positive developments remain in place: (1) the breakout above the multiple-year consolidation box (point A), (2) a retest of the breakout (point B), and (3) a bullish MACD crossover near point C.

A December 2 analysis provides some historical context (1993-2017) for the bullish monthly MACD cross shown above.

The View From 90,000 Feet

This week’s stock market video covers an extremely rare breakout attempt that is being made by the broad NYSE Composite Stock Index and puts the development into some long-term historical context (1965-2017)

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Trump Moves On Regulatory Reform

As outlined on November 11, reducing regulations could have a positive impact on earnings. Monday, President Trump moved on regulatory reform. From Reuters:

President Donald Trump signed an order on Monday that will seek to dramatically pare back federal regulations by requiring agencies to cut two existing regulations for every new rule introduced. “This will be the biggest such act that our country has ever seen. There will be regulation, there will be control, but it will be normalized control,” Trump said as he signed the order in the Oval Office, surrounded by a group of small business owners.

The Mother Of All Stock Market Signals

January 27, 2017

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Are Stocks Set Up For A 2011-Like Plunge?

January 23, 2017

2017 Momentum Has Been Waning

The S&P 500 has been treading water for six weeks, which means bullish momentum has been getting weaker and weaker. Given what we know as of January 23, what are the odds the S&P 500 plunges this week in a manner similar to the 2011 plunge shown below?

Yellow Flags Typically In Place

Markets can do anything at any time; an expression that applies to all markets, including the present day market. Having said that, waterfall plunges typically do not come without some type of observable deterioration already in place. The 15% plunge in 2011 occurred between the close on July 28 and the intraday low made on August 9.

How Did Stocks Look Before The 15% Plunge?

Prior to the 15% drop, the S&P 500 had been moving sideways for six months (orange line below), which speaks to indecisiveness and waning momentum. The market had also made two discernible lower highs (1 and 2 below) relative to the high made in early May 2011.

Compare and contrast the 2011 chart above to the 2017 chart below. Instead of a six-month period of indecisiveness, 2017 has seen six weeks of consolidation, meaning the loss of momentum was much greater before the market plunged in 2011. Instead of making two discernible lower highs, the 2017 market made a new high 17 calendar days ago (point A below). In 2011, the last new high was made 87 days before the 15% drop.

How Much Damage Was In Place Before The 2011 Plunge?

In the next set of comparisons, we will remove price from the equation and focus on trends. Moving averages help us monitor the never-ending tug of war between bullish conviction and bearish conviction. Remember, the plunge in 2011 occurred between the close on July 28 and the intraday low on August 9.

The chart below shows various daily moving averages for the S&P 500 on July 28, 2011; the moving averages range from the 40-day (dark blue) to the 150-day (lime green). Notice how the 40-day moving average peaked two months before the waterfall decline (point A). The fastest moving average had also moved from the top of the cluster to the bottom of the cluster, which spoke to the magnitude of the deterioration in bullish conviction relative to bearish conviction. Also notice how tight the cluster of moving averages were on July 28, and how the slopes had moved from positive to neutral or negative.

The 2017 chart below allows us to compare and contrast the exact same moving averages as of January 23. Instead of making a new high months earlier, the dark blue 40-day moving average is still making new highs. Unlike the tepid slopes in 2011, the slopes of all the moving averages in 2017 look much healthier from a bullish conviction relative to bearish conviction perspective. In 2011, the 40-day had migrated to the bottom of the moving average cluster; today, the 40-day remains firmly on the top.

Additional Historical Comparisons To January 2017

This week’s stock market video uses similar “facts in hand” charts to make comparisons to 1982, 1987, 1994, 2000, 2003, 2007 and 2009. The video helps us better understand the long-term bullish case relative to the long-term bearish case.

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How Can The Charts Help Us?

Charts cannot predict the future. Charts help us monitor the probability of good things happening relative to the probability of bad things happening. The probability of bad things happening was higher on July 28, 2011 than it is today. Regardless, the probability of bad things happening is never zero, something that remains true in 2017.

The charts above do not tell us much about the next few hours or next few days. However, given the information we have in hand today, which reflects relatively strong bullish conviction vs. bearish conviction on numerous timeframes, any pullback in stocks has a better than average chance of eventually being followed by new highs.

This analysis is based on the look of the charts as of January 23. If the charts deteriorate in the coming days and weeks, a new assessment would include a bump higher on the “probability of bad things happening” side of the bull-bear ledger. Only time will tell.

Long-Term Bullish Case vs. Long-Term Bearish Case

January 20, 2017

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