Stocks Overbought for Short Term

Market Updates

Stocks Overbought for Short Term

Mike Gibbs, Managing Director of Equity Portfolio & Technical Strategy, discusses the roaring start equities have had in 2018.

January 23, 2018

The year is off to a roaring start for the U.S. equity market, as the benchmark S&P 500 has sprinted out to just under a 5% gain in the first 13 days of trading. This comes on the heels of a 6% fourth quarter rally. Economic data, expected earnings growth, flows into equities, and investor sentiment firmly support a healthy environment, but we think the rate of gain (over 60% annualized year to date) is due to slow. For this reason, we would be patient and wait for consolidations or pullbacks at the sector or stock level before adding to holdings.

The political battle over the budget will remain in the headlines, but we expect earnings reports are likely to be the main driver of equities over the next 30-plus days. According to estimates compiled by FactSet, earnings growth should be supportive of equities as low double digit growth is projected for 4Q17 as well as over ensuing quarters. Yet, after the rally, and with expectations high, we believe reports will likely need to surpass expectations to avoid weakness at the stock level.

Technically, stocks are obviously overbought for the short term. The S&P 500 currently trades 11% above its 200 day moving average (DMA). This is the largest premium to the 200 DMA seen by the index in the past 12 months. The March 1, 2017, 10% premium was the previous high for the period. After the March 1 peak, it took the S&P 500 two months to print another high. During those two months a decline of 3.25% developed.

As expected, most sectors of the S&P 500 are extended in price as well. Consumer Discretionary, Energy, Health Care, Industrials, Materials, and Technology are all trading at their largest 12-month premium to their 200 DMAs. These six sectors, along with Financials, are all ahead of the S&P 500 year to date. Energy is the leader with a 7+% gain. Interest sensitives (Consumer Staples, Telecom, Utilities, and Real Estate) are all lagging the S&P 500 for the year. Two of these – Utilities and Real Estate – are trading at the largest 12-month discount to their respective 200 DMA, for any contrarians looking for a potential short-term bounce.

In sum, conditions are healthy for the U.S. equity market. Yet, after a strong move higher, the general market and most sectors are overbought. We think a period of consolidation or even a minor pullback would be a healthy development in the near term.

The S&P 500 is an unmanaged index of 500 widely held stocks. It is not possible to invest directly in an index. All expressions of opinion reflect the judgment of the Research Department of Raymond James & Associates, Inc. and are subject to change. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Past performance may not be indicative of future results.
Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The forgoing is not a recommendation to buy or sell any individual security or any combination of securities.

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