Are Stocks Way Overbought? 34 comments
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Stocks are overbought.
And by overbought, I mean WAY overbought.
The relative strength index (RSI) is a metric used to measure the velocity and momentum of a given investment by comparing its upward and downward moves from close-to-close. If an investment is moving up strongly, its RSI is higher. Similarly, if an RSI is low, it means the investment is performing weakly.
Historically, RSI’s of 70 or higher mean an investment is overbought while an RSI of 30 means an investment is oversold. In these situations the market is primed for a “revert to the mean” trade, meaning you could see a quick correction or turnaround rally as the market snaps back to a more reasonably RSI.
Well, have a look at Friday's NASDAQ.
As you can see, the NASDAQ recently hit an RSI of 75. This is the highest reading we’ve seen in nearly two years. In fact, the last time the NASDAQ had an RSI of 75 was October 10, 2007, right before stocks entered their first major leg down in the Financial Crisis, losing 55% in six months.
As soon as I noticed this, I called up Ron Coby, a brilliant portfolio manager based in Medford, Oregon. Ron’s one of the smartest guys I know and when it comes to trading short-term moves, he’s one of the best in the business. What he had to say completely blew me away.
Ron said,“Graham, you won’t believe this, but I went back on the NASDAQ and made a note of every time it hit an RSI of 75. EVERY TIME, the market collapsed soon after. And I don’t mean a “plain vanilla” correction, I mean a full blown CRASH.”
Ron then forwarded me the following chart. Suffice to say, I was floored:
.
As you can see, the NASDAQ has hit an RSI of 75 or higher five times in the last 12 years. Every time, the market collapsed soon after with an average drop of -22%. In several cases, stocks suffered a full-blown CRASH.
This is a very serious warning for the Bulls. A high RSI doesn’t mean that stocks have to CRASH immediately. But it does indicate that the NASDAQ is more than ready for a serious correction. Again, an RSI of 75 or higher has only been hit FIVE times in the last 12 years. Two of those times were at massive historic bubble peaks. The others were all periods in which stocks were simply far too overbought. And ALL FIVE OF THEM PRECEDED SERIOUS CORRECTIONS.
Be forewarned, if stocks are this overbought, we’re in dangerous territory. If smart money like Ron Coby is worried and shifting to a defensive stance, I’m paying attention.
I suggest you do the same.
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That's the short and skinny of it, as some forgotten financial guru used to say.
Which doesn't mean that we should stop using clear observation and intelligent analysis and turn to mumbo-jumbo cycle analysis and other Ouija board techniques.
We should, however, keep a history book open at all times and dip into it daily just to remind ourselves of how irrational homo economicus really is.
fyi- Dr Stephen Leeb just sent out a crash alert.
A high RSI can simply be a sign of strength in the market. It is misleading unless the market is oscillating.
I'm not saying the market's going higher, I'm just saying decide on some other basis.
stockcharts.com/h-sc/ui?s=$NDX
The standard graph will show RSI along the top. Set the dates to show you 2003. See the RSI hit >75 in Sept and watch the NASDAQ keep riding up.
On Aug 10 05:09 PM Swashbuckler wrote:
> Chap08---I would like to see the author or a reader reconcile your
> readings of RSI with the author's. I doubt both versions are correct,
> and if you are correct, then IMO, the article has been gutted.
On Aug 10 05:09 PM Swashbuckler wrote:
> Chap08---I would like to see the author or a reader reconcile your
> readings of RSI with the author's. I doubt both versions are correct,
> and if you are correct, then IMO, the article has been gutted.
For a metric that tells me stocks are greatly overbought is shown on the graph at www.bullandbearwise.co... which shows the S&P 500's average PE ratio. If you click the drop down box, compare that against Capacity Utilization. That's all anyone should need to see.
Was anyone impressed when the Unemployment rate moved from 9.5% to 9.4%? Sure they were, but they were wrong. The reason it fell was the huge number of Unemployed people who are still unemployed and will no longer be receiving checks. I watched the weekly continuing claims number falling for weeks
On Aug 10 12:12 PM Mad Hedge Fund Trader wrote:
> Yes Siree! Looks like I am going to have to be the designated driver
> at this brewfest. The Friday nonfarm payroll showing losses of only
> 247,000 jobs, with upward revisions to May and June, is signaling
> to many that the bull market is back. We’re definitely getting worse
> at a slower rate. You might as well put a giant neon sign on your
> roof saying “party here tonight.” One can never underestimate the
> animal spirits here. I’m sure the newspapers are going to call the
> 0.1 % micro improvement in the unemployment rate to 9.4% as the beginning
> a major trend. But look at the chart below, which shows were aren’t
> close to a turnaround in the worst jobs turndown since the thirties.
> I don’t see any new consumers on this chart, and I was able to breeze
> through my favorite restaurant at lunch because it was still half
> empty. I think what is really happening here is that having priced
> in Armageddon in March, we are now pricing it back out. What’s an
> Armageddon worth? Some 3,000 Dow points, or 350 S&P 500 points,
> about where we are right now, sounds like the right price to me.
> Let me know when you’re ready to go home, and I’ll pile your inebriated
> carcasses back into the car. I’ll even take the breathalyzer test.
On Aug 10 03:34 PM chap08 wrote:
> This is simply wrong. The NASDAQ hit an RSI of 75 in 2003, 2004,
> 2005 and 2006 without crashing.
>
> A high RSI can simply be a sign of strength in the market. It is
> misleading unless the market is oscillating.
>
> I'm not saying the market's going higher, I'm just saying decide
> on some other basis.
Did any of those overbought conditions occur with an S&P p/e trading below 20?..... I don't think so.
Did any of those overbought conditions occur with interest rates at historic levels?..... Nope.
Did any of those overbought conditions occur while worldwide Governments were throwing out Billions of dollars to re-energize economies.... Nope
In fact, Nasdaq's RSI breached 80 in middle of November 1999 at 3000 level. Had you been short back then, well....
Nasdaq's RSI approached 80 again in early July and early September 2003, in the early stage of the last bull market.
Nasdaq's RSI closed above 75 in many instances between 2003 and today, only the very last instance (Oct 2007) led to a serious market crash.
On Aug 10 03:34 PM chap08 wrote:
> This is simply wrong. The NASDAQ hit an RSI of 75 in 2003, 2004,
> 2005 and 2006 without crashing.
>
> A high RSI can simply be a sign of strength in the market. It is
> misleading unless the market is oscillating.
>
> I'm not saying the market's going higher, I'm just saying decide
> on some other basis.
Were these "bullish" periods have these going against it:
Why we're near the very top:
1. Goes up on bad news from MSFT, AMZN, AXP's poor numbers results few weeks ago.
2. The investment gurus and analysts who got blind sided by last fall's fall and March low (boy weren't they pessimistic) are now in unison as bullish as ever, even with heck of a run since March.
3. Bears are hiding and appear to be capitulating on short covering. One can say the bears were "early" smart money.
4. Russell 2k has been on a tear. Speculation galore or halcyon days are back?
5. CNBC has special on Dow 9k and Cramer is pounding the table with buys and the lemming retail and professional investors are piling in. So much for the lows we had in Oct/Nov and March.
6. And even Barron's sounding bullish sans Abelson?
7. Historically Sept is the worst month followed by Oct. Just around the corner.
8. Low volume on recent rally in last month or so despite program trading. Volume proceeds price. Lack of volume on follow-thru to S&P 1k and Nas 2k portend downside ahead.
9. Lowry’s Buying Power Index nudges record 1933 low. Few breadth studies are as insightful as those provided by Lowry Research since 1931.
"The key to Lowry’s is not the absolute level of its Buying Power Index. It’s the relationship between Buying Power and Selling Pressure. The span between declining Buying Power and rising Selling Pressure hit a 78-year record distance of 807 on July 8. The wider the span, the more bearish the situation.”
10. Very heavy insider selling. Insider selling to buying is 4.16 to 1 in July compared to 0.76 to 1 in March.
Takeway?
My 2-cents is that we'll see 50% retracement to March low in Sept/Oct.
This is a notoriously bearish forum. I'm seeing just as many bears today on this site as there were in March.
So who are we being contrary to?
Just a thought...
btw, I'm on the bear/bull fence right now...
Ken Fisher, long time contributor to Forbes has a recent article "The Bear Market is Over" and cites some reasonable support:
Money market cash, in comparison with value of all stocks, is twice what it was in 1982 housing affordability now excellent: median home price in the U.S. is 2.8 times median family income, down from 3.9 times three years ago. global leading economic indicators in total (such as real money supply and the yield curve's slope) highest they've been in a decade. Productivity is up 2% from a year ago impressive growth within a recession's decline
Then there is the work of Kevin Hassett, of the Amer Enterprise Institute on the TED. AEI is a conservative organization, but Hassett has worked for both the Clinton and both Bush Administrations in economic advisory positions.
TED is a measurement of the spread between the LIBOR rate (rate at which banks lend to each other) and 3 month Treasury rate. In the past when it goes above 2.5 % a market crash soon ensues, when it returns to its historic norm (which it now has) of around .5% (in fact that is low) the market rebounds to normal. Essentially -- when it is up, banks are indicating an unwillingness to lend to each other, credit is tightening, and then, as it did last year, credit freezes, crashing the system.
Markets fluctuate for many reasons, sometimes it seems for no reason at all, so I find it hard to place my bets between all the foreseerers -- the bears and the bulls. But there is one old adage that seems appropriate for this time, this season : 'don't fight the tape.'