When stock indices show signs of being overbought, they usually outperform**, S&PThe 500 and Nasdaq are currently overbought, but historically, they have hardly become more overbought before reversing.
Market tops and market bottoms are different: the former is a process, while the latter is usually an event that occurs suddenly. Market tops last longer, often for months, which means they tend to show signs of continued upside. This means that an overbought market may become more overbought before capitulating.The S&P is now showing signs of being overbought. The index's annual return is reverting to the mean. The market has recently reached a standard deviation line, but as the chart below shows, it is still possible for the market to become more overbought. This is especially true when the market goes from an extremely oversold state**, as was the case for the S&P 500 at the end of 2022.
The S&P's 14-day RSI is also just below 70 (above 70, the market is generally seen as overbought).If we look at the average forward returns of the index for all time periods (going back to 1970) with an RSI above 70, we can see that the 3-month returns are about the same as the overall sample average, while the 6-month and 12-month returns are higher than their averages.
If we look at the RSI internal indicator, which is the percentage of the S&P 500** where the RSI exceeds 70, it becomes clearer that overbought does not prevent further**.
This indicator reached a series of highs at the end of last year, but we now know that this did not lead to a sell-off, on the contrary, the market moved sharply higher.
At the same time, the market is less overbought on this indicator, falling back to 15%.
When the market is overbought on the RSI internal indicator (with a threshold of 30, i.e. as long as the RSI above 30% of the ** exceeds 70), the market is slightly underperformed on a three-month basis, largely flat on a six-month basis, but outperformed on a 12-month basis.Opt for another measure of overbought: the percentage of the S&P index with volume above the 200-day moving flat**, and the situation is similar.
Historically, the global market, especially in the U.S., has outperformed expectations in 3, 6 and 12 months if 70% is used as a cut-off.
