Many technical analysts on the Street are highlighting the risk of a pullback for equities given short-term technical indicators have moved into overbought territory.
The mistake here, in my opinion, is obsessing over short-term trading indicators when there is a much bigger bullish trend just getting underway. In other words, don’t lose sight of the forest, or the longer-term bullish market cycle, for the trees, the shorterterm noise emanating from the media and Twitterati. The key point is that in strong uptrends, which I see developing here, trading indicators can stay overbought for extended periods, leaving investors who don’t participate staring at the back of the train as it leaves the station.
The chart below illustrates the Standard & Poor’s 500 index price in the top panel and its short-term 14-day relative strength index (RSI) momentum in the bottom. There are two important points both traders and investors should consider. First, the S&P is in the early stages of breaking out of a broad trading range dating back to the middle of 2018 and arguably back to Q1 2018.
Second, after the 5% or so surge in October into November, it’s not surprising to see the daily RSI momentum in the bottom panel become overbought. But should you follow the gloomy headlines and sell, to micro-manage the pullback in hopes of buying back at the ideal entry point?
I strongly caution against that given that our long-term cycle work continues to suggest the S&P is in the early stages of a very normal 4-year bull market cycle that should carry the current cycle to a peak somewhere in 2021-2022. For those that are more tactical focused, weekly indicators, tracking 1-2 quarter shifts are unlikely to become overbought and peak until at least mid to late Q1 which should be followed by another pause into the summer of 2020.
Bottom Line: Stay fully invested, add to cyclicals on near-term pullbacks and use the current bounce in defensive stocks and bonds as an opportunity to reduce exposure.
Noteworthy
Expect further short-term backing and filling by cyclicals following their recent surge in October-November. Daily momentum indicators, tracking 2-4 week shifts are overbought for financials and industrials and oversold for utilities and staples. My outlook remains unchanged viewing near-term pullbacks in cyclicals as opportunities to increase exposure there and bounces in safety sectors as occasions to pare exposure.
Elsewhere, technologies leadership remains intact.
