Market Remains Overbought, But Don't Expect a Major Pullback

Includes: DAYYF, OLN, SPY
by: Jeffrey Saut

Excerpt from Raymond James strategist Jeffrey Saut's latest essay, published Monday (Sept. 21st):

“Do you sincerely want to be rich?” What a great question. But to accomplish that goal, to make those “outsized” gains, you need to know one thing – in a bull market don’t lose your entire position! Certainly you can rebalance positions (read: sell partial positions) as the security in question rallies. However, never lose your entire position.

To be sure, you will hear a lot about how overbought the stock market, an individual stock, a bond, an index, etc. is, yet stocks can stay overbought longer than most participants think. And, that is why we have repeatedly stated – cautious in the short-term . . . yes, but don’t get bearish. Case in point, recently much has been made about the S&P 500 (SPX) being roughly 20% above its 200-day moving average (DMA @892), the widest margin since 1983. Accordingly, we went back and studied that timeframe, as well as the 1975 timeframe, given that both of those periods marked the beginning of new bull markets.

Looking carefully at the nearby charts [see below] from our research affiliate Credit Suisse, we see that the S&P 500 first achieved the 20% “spread” in November of 1982, yet stayed some 20% above its 200-DMA until May of 1983. Clearly, there were pullbacks over that timeframe, but they were all shallow and brief. The 1975 experience shows much the same pattern. To us, this is the way we think it will play this time as well.

In conclusion, while the stock market remains overbought – 92.4% of the S&P 500 components above their 50-DMAs, 94.6% above their respective 200-DMAs, and the SPX currently resting 17% above its 200-DMA – we continue to believe any ensuing “pullbacks” will be shallow. If correct, our preferred investment strategy is to “scale buy” large cap, dividend paying, and fundamentally sound stocks. In past missives we have mentioned numerous names on this theme, along with special situations like 8.4%-yielding Daylight Resource Trust (OTC:DAYYF) and 4.4%-yielding Olin (NYSE:OLN), both of which are rated favorably by our fundamental analysts and/or our research affiliates. Also worth mentioning is that Henry Hub Natural Gas looks to have made a “spike reversal” bottom, leaving its price up 6.2% last week. We continue to invest, and trade, accordingly.

The call for this week: For underinvested participants, we continue to like Riverfront Investment Group’s strategy for committing new capital to stocks. To wit, “First, identify the quantity of cash to be put to work – example: 20%. Second, break the trade into digestible chunks – example: break it into four parts, 5% each. Third, implement the first trade today – example: invest 5% into equities today. Fourth, set a date for implementing the second trade – example: two months from today invest the second 5%. Fifth, implement third and forth segments if market pullbacks occur – example: invest the remaining 10% of the cash on market pullbacks. And sixth, after the date of the second trade occurs, return to step one with the remaining cash – example: two months from today, if the market never provides the opportunity to buy on a pullback, break the remaining 10% up into 3-4 parts and follow a strategy similar to the one utilized for investing the first 10%."