There are very few conditions in which we have any specific expectations for near-term market action. The exceptions are when the market is strenuously overextended in a “trap door” situation combining rich valuations with unfavorable internals, or when the market is strenuously compressed following a material improvement in valuations.
Over the past four decades, I’ve developed scores of interesting “syndromes” and relationships, many that I’ve discussed in these market comments. A subset of these capture features of “overextension” and “compression” that occur at major market extremes.
The chart below shows one such syndrome that emerged in mid-April as the S&P 500 advanced above 4400, and again last week, which I consider part of the same overextended advance. The criteria are intended to capture a certain “relentlessness” of speculation that often precedes abrupt market losses. This particular syndrome is among several that I monitor to identify speculative “blowoffs.”
In this case, “relentlessness” is defined by periods when the S&P 500 is at least 4.5% above its 50-day average, with a relative strength index (RSI) above 70 – indicating a preponderance of advancing days relative to declining days in recent weeks, a 14-day rate of change (ROC) greater than 4% in the S&P 500, and at least a mildly bullish tilt in advisory sentiment, based on Investors Intelligence data. Periods like this look briefly parabolic, as investors increasingly buy every dip, in fear of missing out.
The Nasdaq-100 is back testing its all-time peak and the dominance of the FANGMANT shares is now both more concentrated and dominant relative to the wider market than at the peak in late 2021. That alone is grounds for caution but it is not a timing indicator, the overbought conditions can progress even further. It is, however, a very good time to have one’s stop strategy in place.
The mania surrounding artificial intelligence was prompted by the release of large language models but the most promising utility of big data & AI is in the materials, healthcare and energy sectors. The big question then is whether AI will provide day to day productivity enhancements or create more work through the necessity of proof reading and fact checking.
Several of the largest companies also exhibit RSI divergences. That’s also bearish but is not a strict timing indicator either.Back to top