Jan 24, 2012

Markets Overbought In Short Term

Beginning of the year was impressive for stocks. S&P500 climbed 4.1% year to date and 19.10% since 4th of Oct 2011 bottom as markets exit the most severe market correction since Jul 2010. Still overall sentiment is positive but breadth indicators start showing some overbought signals.

First chart shows correlation between percentage of S&P500 companies above 50-day moving average and S&P500 index. The percentage of S&P500 companies above 50-day moving average indicates short term stock sentiment. Readings above 77% (+1 standard deviation) point overbought market. Currently 85% of the 500 companies in the S&P index trade above their 50-day MA. That is extreme ratio that market could stand for a while, as it did between Oct and Dec 2011, before we see some correction.

The second chart plots S&P500 index relative to 200-day moving average. This indicator measures long term market sentiment. As shown on the chart the index is 5% (1.05) above 200 MA. This level is close to its mean (1.03) suggesting that there is still room to grow.

VIX indicator or fear gauge (third chart) crossed under 20 for the first time since end of July signaling markets volatility is slowing and according to some analysts it is clear buy signal. However historical review of the correlation between the VIX and S&P500 suggests that extreme low VIX levels appear to be sell signals.

It is not clear whether the time for correction has come as short term indicators showing overbought signs while long term sentiment is still positive. Earnings season is still on the move and positive surprises could lift stocks additionally.

Breadth indicators show mixed signals

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