Market volatility can play with your emotions. We all know the feeling of having an investment skyrocket in value and feeling fantastic. And we all know what it feels like to have something absolutely crater and feeling depressed about it.
And somewhere in the middle lies the truth. For the most part, markets move along in a fairly normal state. There are highs and lows, but not necessarily tremendous extremes.
But sometimes extreme conditions occur. The latest happened just recently when the market had its worst December performance since the Great Depression. Then, we had the best January in 30 years.
That tells us that the market was oversold after December and smart traders swooped in to pick up bargains. And since then the rally has continued.
As you can see in the chart below, since the turn of the calendar into January, the benchmark S&P 500 is up just shy of 8%.
That’s pretty impressive for 8 weeks.
But now we’re in danger of the opposite extreme from December – the market is overbought. The gains have all happened so fast…..are we due for a correction back to a mean?
It’s not that we are headed into a recession, but that we might be in for a natural downside when the market shoots up as quickly as it has.
John Jagerson and Wade Hansen, the editors of Strategic Trader, recently weighed in with their analysis. John and Wade are both Chartered Market Technician (CMT) designees, technical experts and some of the best market analysts in the business.
They do a great job helping their subscribers spot and interpret the market signals that matter most and they pointed out that the S&P is developing a familiar pattern.
Here is an excerpt from their latest analysis sent to their Strategic Trader subscribers.
We have pointed out in several previous updates that interest rates and stock indexes tend to move in tandem. This may sound contrary to conventional wisdom, but it is because both values are influenced by the same underlying factors. For example, higher economic growth (good for stocks) also increases inflation expectations (bullish for interest rates).
A short-term warning sign of weakness in equities is triggered when stocks are rising in value without long-term yields. As you can see in the following chart, the most recent stock rally has not been accompanied by a proportional gain in the 10-year yield, which increases the risk of a short-term correction.
Although we have experienced very little volatility on the major stock indexes since January, the S&P 500 is approaching the point at which the market last encountered serious resistance. Between October 17th and December 3rd, the S&P 500 was rejected lower from $2800 three times.
Investors tend to struggle with what we call an “anchoring” bias where they remember or are anchored to prior inflection points. It is one of the prevailing theories of the cause of resistance and support levels. Every time the index approaches a level like this, we have to consider risk is elevated.
So, it’s looking like some sort of correction is a real possibility.
They’re not the only ones with this feeling.
Legendary investor Louis Navellier, editor of Growth Investor, also believes the broad gains for the S&P 500 are not sustainable.
In his latest update to his subscribers, Louis notes that the underlying market fundamentals forecast that the broad market upswing so far in 2019 is reaching an end.
This rising tide has lifted nearly all boats, and as result, the stock market is grossly overbought. In fact, according to the folks at Bespoke, more than 70% of S&P 500 stocks are now in overbought territory. That’s the highest level in nearly three years. Historically, this 70% overbought threshold has only happened eight times in the past decade.
Interestingly, it did little to dampen spirits on Wall Street. In fact, Bespoke noted that the S&P 500 has risen a median of 2.1% in the following month and 5.6% in the three months after the stock market has breached this overbought threshold. So, the good news is that the S&P 500 should continue to move higher in the coming weeks.
With that said, though, I expect the S&P 500 to climb higher at a significantly slower pace. All of the easy money has been made, and the stock market is set to narrow in the coming months. The reality is that the S&P 500’s earnings are expected to “hit a wall” due to more difficult year-over-year comparisons and a strong U.S. dollar.
Picking the winners is going to get tougher.
Louis has a well-earned reputation for making money in any market conditions. Picking the winners, even when the market may be headed for a bit of a correction, is why so many people depend on his advice in Growth Investor.
One of the keys to becoming a great investor is managing market extremes. As part of his series on growing your wealth, our CEO, Brian Hunt, has even written an essay for our Education Center about becoming A Connoisseur of Extremes.
As the market shows signs of being overbought, make sure you don’t overreact too far to the downside. Or, use any market dips as an entry point for the stocks on your watch list, understanding that you’re going to have to be more selective in an environment with narrower market gains.
To a richer life…
Luis Hernandez, Managing Editor
and the research team at InvestorPlace.com