It's Overbought, But Don't Sell Yet

02/15/2013 10:30 am EST


Dan Sullivan

Editor, The Chartist

While the markets may appear to be extended a bit more than investors would like, there are plenty of indicators pointing the way to further gains, writes Dan Sullivan of The Chartist.

Many analysts contend that stocks are overbought as well as overextended. However, overbought markets can and often do become more overbought, which is exactly what has occurred over the last several trading sessions.

Our Overbought/Oversold indicator registered a heavily overbought +3.53 on January 2. Since that time, stocks have worked their way persistently higher, with the Dow Transportation Average (up 7.71%) leading the way, recording bull market highs and all-time highs as well.

The Dow Industrials confirmed the breakout of the Transportation Average on January 18, when it managed to close above its prior bull-market highs set back on October 5. This triggered a Dow Theory buy signal.

This is a powerful bull market—make no mistake about it. The year certainly got off to a good start with the Chartist Volume Thrust indicator flashing a strong buy signal on January 2. On December 31, upside volume overwhelmed downside volume by 27.95:1, and did so again on January 2 by 11.55:1. Since 1958, there have been only 14 prior volume thrust buy signals.

Many analysts feel that the giant pension and insurance funds are overweighted in bonds. It is only a matter of time before they begin to rebalance.

The public also appears to be coming back, since US equity funds took in $11.3 billion in the first two weeks, which was the largest two-week inflow in a decade. The inflow into exchange traded funds was in excess of $18 billion, which was two times the equivalent inflow into bond funds.

Given a choice between the two—equities or ten-year US Treasury Bonds—the obvious choice is equities. At this point of the cycle and given its extremely low yield, the US bond market is just as vulnerable as the stock market.

There is no question that the S&P 500 is bumping up against formidable overhead resistance, because 1,500 is within the range in which the last two bear markets began. The 2000 and 2007 peaks represent a long-term double top. If the S&P 500 can punch its way through with authority in the not-too-distant future, it will represent a strong plank in the bullish case.

We suspect it is only a matter of time because the equal-weighted S&P 500 has already taken out its prior historical highs by a significant margin. Also note the Daily Advance/Decline line is also in record high territory.

While many analysts are looking for a correction to take hold at any time, we are of the opinion it will come from higher levels. We expect corrective activity to be limited in scope over the next several weeks.

Besides the volume thrust buy signal, the Chartist 90% rule is right on the verge of flashing a buy signal. Currently 89.17% of the stocks on the NYSE are above their respective ten-week moving averages. A couple more days of upside action will no doubt generate a 90% reading, thus triggering a buy signal.

With our models in a positive mode, we continue to advise a fully-invested position.

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