Mid-week market update: The SPX has staged an upside breakout to new all-time highs and indicators are looking overbought. Now the key question for traders is whether current conditions represent an extended market that`s ripe for a pullback, or does do these conditions represent a “good” overbought condition that accompanies a momentum surge, which leads to a Fear Of Missing Out (FOMO) rally?
Overbought market = Imminent pullback?
The warning signs are there as the market certainly appears to be extended, As the chart above shows, the SPX is overbought on RSI-5. In addition, breadth metrics from IndexIndicators show that the market is rolling over from an overbought condition – which is a sell signal according to many trading systems.
Similarly, the CNN Money Fear and Greed Index also appears to be extended and at a crowded long reading.
Momentum surge = Higher prices?
On the other hand, a case could be made that this market is undergoing a momentum surge, which is bullish. Rob Hanna at Quantifiable Edges wrote this analysis back in 2014 when the market experienced a similar surge when prices bounced off a bottom and went on to make new highs. While the number of observations are low (N=7 today), such episodes have seen the market top out about a month later (annotations in blue are mine). As last Friday was the “signal day”, this analysis suggests that the current rally has significant upside potential.
Here is what happened in 2014. The vertical line in the chart below shows the date of the signal. The market consolidated and ultimately topped out about a month later with a 1.0% gain, which is significantly lower than the average 4.3% gain shown in the backtest.
Here is the chart of the SPX today. Arguably, the market was not overbought to the same degree as the 2014 episode at the time of the signal and therefore it has further room to run.
Other analysts, like Dana Lyons, have documented the historical effects of the bullish implications of a price momentum surge.
Nautilus Research shows what happened when the market hit and all-time-high. Such episodes have historically seen bullish follow-through.
Buy the dip!
Here is my take: I interpret these readings as a legitimate momentum surge, which tends to resolve itself bullishly. In the short-term, pullbacks can happen at any time and they are likely to be shallow. If my inner trader wasn’t on vacation, he would be aggressively buying any dips in anticipation of higher prices.
As always, thanks!!
Have a good vac.
Sentimentrader.com talked about how upside volume was over 70% for 10 days straight. This last happened starting the 2009 bull market.
They also noted that there can be short term small weakness but intermediate and longer term unusual strength.
This is the bull market driven by lower for longer acceptance and the generous dividend yield of global markets. That dynamic doesn’t call for frenzy but rather a grinding uptrend.
I am watching intraday pullbacks, that are being bought. This happened yesterday and today. Futures, as I write, are in the red. We will see what happens when the cash market opens (would like to see cash market in the green, confirming the premise that money should be on the long side of the ledger). Of course, JPM earnings today could have been the green signal. Tomorrow, Citi, Wells Fargo, US bank corp, PNC etc. would set the tone. So far, Cam’s analysis is absolutely spot on. Minor intraday dips are being bought. Yesterday’s oil sell off did not matter. I am sure, there is a larger sell off here somewhere, but a close tomorrow above 2135 (previous closing high, circa 2014), would be a bullish close. A second friday close (a week from tomorrow) would be strong technical evidence, confirming long side bias. Bond market sold off today, but the market rallied. Barring any unusual events overnight (like new QEs or geopolitical events), tomorrow’s market behavior/market close/intraday action is worth watching.