Just how frothy is the stock-market rally right now?
Consider this stat: Just under half of the S&P 500 components now have a relative strength index reading over 70, a level considered to be overbought. The relative strength index (RSI) is a popular momentum indicator that rises as the number, and size, of up days increase.
Andrew Greenebaum, senior vice president of equity product management at Jefferies, points out that similar situations have occurred only a few times since 1990. Those times were when at least 45% of S&P 500 components had overbought RSIs.
Implications for Future Performance
According to Greenebaum, despite an RSI reading over 70 being a trusted signifier of an overbought equity, when it happens to half of the index, it’s a pretty good sign. In fact, the 12-month performance afterward showed an average gain of 13%, with every instance being positive.
Looking at a broader pool of data, there have been 21 instances in the past 33 years when at least 30% of S&P 500 companies were in overbought territory. In these cases, the average 1-month performance showed a decline of about 1%. However, the average gain over 12 months was 12%.
Greenebaum emphasizes that although jumping in at the overbought point may come with some risks, it could also signal the start of the process toward a fresh all-time high for equities.
As of now, S&P 500 futures were higher on Monday, and the Dow Jones Industrial Average has already notched three consecutive record highs.