04 May 2008

Overbought Danger Signs for the Market

Trader's Narrative offers up some graphical evidence that the market is getting a bit overextended:

Here's yet another metric showing that the market may be approaching overbought conditions:
percent spx above 50 MA april 2008

For those unfamiliar with this indicator, it is the percentage of stocks within the S&P 500 Index (SPX) which are trading above their simple 50 day moving average. So for example, if we had 100 trading above and 400 trading below, that would give us 20%.


Getting back to current market conditions, we are now slowly approaching the other extreme: overbought. We aren't there yet. Usually the market tops out when this percentage gets between 80% and 90%. When the market topped out in October 2007, this indicator reached 85%. But right now we are only at 74%.

So its just something to watch out for. Especially when compounded by other sentiment and technical indicators which similarly argue for a pause or retreat.

Trader's Narrative also believes that recent low volume offers up a caution sign for this rally.

The above chart is quite thought-provoking. I agree that it's another tool in the mental arsenal. But if you look back to August of '06, the market was at a similar overbought level. The market continued moving higher, to more overbought levels for most of the rest of '06 until the breakdown in late February '07. If the current market paralleled the market of August '06, we could conceivably see another six months of bullish market behavior.

On a similar note, Bespoke Investment Group offers up charts of the S&P 500 and individual sectors showing the current market's overbought condition. I've excerpted the first two charts from Bespoke, but click the link for the rest of their informative charts.

Below we highlight the percentage of stocks in the S&P 500 and its ten sectors that are currently trading above their 50-day moving averages. As shown, 77% of stocks in the S&P 500 are currently above their 50-days, the highest level seen since last October. While it's good to see markets doing well again, things have gotten overbought over the last week or so.

Currently, 85% of Financials, 80% of Industrials and 80% of Technology stocks are above their 50-days. The only sectors with a downward trending breadth line are Energy and Materials. After hitting a rough patch in recent days, the percentage of Material stocks above their 50-day moving averages has dropped to 54%.



Then I found this piece from Investment Executive, a magazine for Canadian financial advisors. Here's the back bacon:

A majority of financial analysts in believe North American markets will continue to fall, according to a poll released today.

When asked if the North American markets have hit rock bottom, 61% of Canadian Chartered Financial Analysts (CFA) respondents said no and only 17% replied yes. "There is lack of confidence in the financial system," said one respondent. "Both Canadian and American economies are in good general shape except for problems in the financial sectors. The bottom is much deeper than most of us could imagine."


The poll was conducted between April 15 and 17 and CFAs from all 12 Canadian CFA societies across the country participated.

Finally, I've loaded up my current RSI (2)/(14) chart below. The RSI (2) for the Dow on Friday closed at a 94, which is short-term overbought. The RSI (14) of 66 is approaching the longer-term overbought value of 70. 18 out of 30 Dow components are in the red.

No comments: