The last time the market started the year off this fast, I was nine years old. In fact, there are only four other years in history when the S&P500 had a better first 15 days to start the year (1987, 1976, 1967, and 1938).
According to the Stock Trader’s Almanac, the month of January in a mid-term election year is usually a very poor one. As you can see in the chart below, the average market performance in January is actually down about -1.8%. In reality, however, this market has shot up and surpassed what normally would be the mid-April high in a “normal” mid-term election year.
Now, while this market continues to go parabolic, likely due to the passing of the tax bill in December, it can’t continue “inhaling” without eventually letting some of the air out of its tank. While it’s been a great run, there are two things that investors need to watch out for.
First, the chart below is the S&P 500 with a 1-month trendline plotted with 3% “cushions” on either side of the trendline. The black line is the market itself, the dotted line is the 1-month trend, and the lines on the top (+3%) and bottom (-3%) are the “cushions.” <Nerds note: This is a 21SMA w/ 3% envelopes>
Notice how each time the market touched or crossed above the top of its 3% tolerance band, it went through a period of slowdown at the least. Now, notice that we’ve crossed above this +3% tolerance band again, but in parabolic fashion.
Secondly, as I wrote in last week’s commentary, the market is more overbought (overheated) than it’s been in decades. The top pane in the chart below is the S&P500. The middle pane is RSI (relative strength index) which measures overbought and oversold levels. This chart only goes back to 1990, but look at how there hasn’t been a period more overbought than right now, even considering the 2000 dot-com bubble and the 2007 mortgage crisis peak.
In addition, if you look at the bottom pane in the chart above, this is an indicator that measures how strong the current trend is (up or down). The first peak I circled was the strength of the downtrend during the -57% market crash between 2007-08. The second one is the current uptrend, which as you can see, has become almost parabolically positive as the mortgage crisis meltdown was parabolically negative. Point being, the strength of this trend is nearing a peak not seen in recent history.
Now, with that all being said, I’m not calling for a crash just yet. I think that this market has legs and that we should continue to see positive market performance over the next several months. When the market gets extremely oversold on an intermediate/long-term basis, that’s a bearish sign. So, with the market being overbought right now – that’s good for the intermediate/long-term.
However, in the short term, I expect a pullback will take place as part of the normal “breathing” pattern that markets naturally exhibit over time.
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Adam D. Koos, CFP®
President / Portfolio Manager