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The Dow is trading at one of its most overbought levels in history. At 87.61, its 14-day RSI is higher than 99.999% of historical readings going back to 1900.
Out of 30,914 trading days, that’s good for top 10 all-time.
If only it were that simple. Going back to 1900, the evidence suggests that such extreme overbought conditions (>99th percentile) are actually bullish in the near term, on average.
Come again? In the year following extreme overbought readings, the Dow has actually been higher roughly 70% of the time with an average price return of 14.2%. From 5 days forward through 1 year forward the average returns and odds of a positive returns are higher than any random day. While the 3-year and 5-year forward returns are below average, they are still positive.
Note: The above table is price only. The returns would be higher if dividends were included.
Does that mean we’ll continue higher today? No, these are just probabilities, and 30% of the time the Dow is lower looking ahead one year.
What it does mean is that one cannot predict a market decline based solely on extreme overbought conditions. Declines can happen at any point in time and “overbought” is neither a predictor nor a precondition of a bear market to come.
If one is going to predict anything based on extreme overbought conditions (and I would advise against doing so), it would be further gains. I realize that doesn’t conform to the conventional narrative of “overbought = bearish,” but the truth in markets rarely does.
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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
You can follow Charlie on twitter here.
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