Where the Rubber Meets the Road
There you have it. With today's gap up open, the market will be overbought. In 9 trading days, the market has gone from oversold to overbought - just like that. Of course, on a fundamental basis nothing has been solved, and the worries of 3 weeks ago -- Greece and the debt ceiling -- are still with us, but more importantly, they will likely be worked out as expected -happy outcomes for everyone. The current solutions may not be the right solutions, but for now, remember that nothing will be done to "roil" -there is that word again- the markets. Technically, and maybe it is a different story here, this is where "the rubber meets the road". Will overbought become more overbought? That is, will prices levitate higher despite the over bought conditions of the market thus launching a new upward trend?
Figure 1 is a daily chart of the S&P Depository Receipts (symbol: SPY). The indicator below is the McClellan Oscillator, which is a measure of the NYSE advancing and declining issues. As you can see, the current indicator value is approaching the upper band indicating an overbought market.
Figure 1. SPY/ daily
Point #1 on the graph is the overbought reading from September, 2010. Prior to this, the market was coming out of an oversold reading where investor sentiment was very bearish. Here overbought became more overbought and the market powered ahead. It is in these kind of conditions where new trends are born. Points # 2- 5 show overbought signals leading to measured pullbacks and new oversold (i.e., buy) signals.
Once again, will overbought become more overbought leading to a new up trend? My guess is that the eventual outcome will be somewhere in between a market that rolls over and one that powers higher. Aside from bearish investor sentiment (which is a bull signal), the two best reasons I can give for the market moving higher the past 10 days are end of the month and quarter mark ups and buying ahead of the July 4th holiday. Then we enter the summer doldrums. Beyond this, the sling shot isn't particularly tight meaning that the oversold and sentiment conditions were not uniformly extreme at the bottom a couple of weeks ago, and despite the selling of the past month or so, the bears never really jumped on this mini-down trend. Without bears to provide short covering fodder, there will be little fuel to power the rally.
When it is time to sell, I think we will be higher, but it seems to me that it will be slow going along the way.
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