Paul Krsek believes the Top is In or Does he ?
Stocks are the Most Overbought in 22 Years! So What?
January 24, 2018
The stock market is the most overbought since Bill Clinton was president, but that may actually be a good thing according to analysts who appeared on CNBC Monday.
Ari Wald, head of technical analysis at Oppenheimer, told CNBC's "Trading Nation" on Monday that the S&P 500's 14-month relative strength index (RSI) surpassed the 87 level for the first time in nearly 22 years.
The relative strength index (RSI) is a charting tool used by every technical analyst in the world. The index ranges from 0 to 100. A market is considered to be overbought when the index is at 70 or above. That is often a time when caution should prevail.
A market is considered to be oversold when the index drops to 30 or below. When the index falls below 30 it has often been a great time to buy bargains.
RSI 87 on the S&P 500 is a level that has been reached only 1 percent of the time since 1930. The other periods in which the index moved that high were in 1996, 1986 and 1955. This was during three of the strongest bull markets in history.
"There's really two key takeaways," said Wald. "One, even when you got to those high RSI readings, it was still followed by above-average returns. Two, the RSI indicator peaked at least a year ahead of the market on all those occasions."
In other words, the stock market kept going up after hitting the RSI 87 level, and it kept going up for quite a while.
Wald dusted off the history books. In 1996, the RSI hit 87 in June - from there to the market peak, the S&P 500 rose 128 percent. A decade earlier, the RSI reached similar levels and the S&P 500 proceeded to gain roughly 50 percent through to the bull market's high.
Going further back, in 1955, the RSI peaked at 88 in July and afterward the market gained around 15 percent through to the top of its bullish stretch.
It seems counter intuitive for the market to be so overbought and yet keep going up. But that is exactly what happened in these major bull market cycles.
The current bull market has run for nearly nine years and most analysts do not see an end in sight. It is the second-longest bull market in history, beaten only by the stretch from 1990 to 2000. Since the bottom in 2009, the S&P 500 has climbed roughly 320 percent. The 1990-2000 bull market rose 417 percent.
"Add it up using history as a guide, and how we see it is these overbought conditions are arguing against the top and instead for a continuation of the bull market," said Wald. He credits "broad-based internal breadth, cyclical leadership, and strong credit" as the main contributors to the markets' strength.
Bill Baruch, President of Blue Line Futures, is also bullish on the S&P 500 even as the equity market trades at its highest level in history.
"The market is not correcting. The question is, where's the next 1 percent to 2 percent? I believe the next 1 percent to 2 percent is higher," Baruch told "Trading Nation" on Monday. "I don't imagine getting any sort of correction until after March."
Baruch targets 2,847 for the S&P 500 for 2018, roughly flat with Tuesday's trading levels. Counting from the beginning of the year, Baruch's target suggests a more than 6 percent gain for the S&P 500 in 2018.
At 5T we have been studying this overbought condition for a few months. It has been easy to see the 87-level approaching and we couldn't help but wonder if it would be reached again. Well, it has.
We are inclined to agree with Wald and Baruch. The market seems to be headed higher. That is not to say we won't have corrections along the way. Baruch says that he does not expect a correction until after March. He doesn't say there won't be a correction.
We have said before that any significant correction will be bought. That remains our "base case" for 2018. In fact, we aren't waiting for the entire market to correct. Individual stocks have been getting hit, here and there, as sector rotation takes place. A few companies have been hit with large losses as a result of the recent tax reform and their shares have been taken down. We are trying to use circumstances like these to buy.
Neither sector rotation, nor temporary hits from one time tax reform have anything to do with the long-term performance of great companies. Therefore, we are buyers. We added to Johnson & Johnson today after a 4.5% decline yesterday. I can't remember a single day that there haven't been J&J products in our home. I don't imagine there ever will be a day. This company just keeps growing!
Wall Street has already had a remarkable run to begin the year. The S&P 500 is up 6 percent, the Dow also 6 percent and the Nasdaq nearly 9 percent for the year to date.
The consumer discretionary sector is the best performer of the S&P 500 year-to-date, while the telecom and utilities sectors are the worst performers.
REITS utilities, and other interest sensitive stocks are actually quite oversold. We are shopping in this market place too because we do not believe that long-term rates are headed significantly higher. It is still smart to shop in the bargain bin from time to time!
Look for stocks to move higher for the foreseeable future, albeit with corrections along the way. Dow 30,000 is not out of the question. Neither is S&P 500 3000. Those are not necessarily predictions, but it wouldn't surprise us one bit if we see those levels sometime in 2018.
All the best,
Paul Krsek
CEO
5T Wealth,LLC
(707) 603-2672 Office
(707) 486-7333 Cell
Paul@5TWealth.com
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