Overbought situations are now reaching extreme levels (SPX)

By Lawrence G. McMillan

Stocks had a small change to their regular pattern yesterday: they didn’t close at the day’s highs.  However, they did open slightly lower and then rallied strongly into mid-day.  After that there was modest selling, but a late rally kept most of the day’s gains intact. $SPX is now in a bit of a rarified situation.  It has once again reached levels that are considered severely overbought – whether you judge that by the fact that it is above the upper Bollinger Band, or if you judge it by the fact that it is 15 standard deviations above its 200-day moving average.  Even so, all that means is that a sideways move is likely.  At this point, we still consider the 1623 area as the first support level.  If it were to be broken, that would probably usher in a larger correction.

Call buying was extremely heavy again yesterday, as many stocks are making new (all-time) highs and are being chased by hordes of speculators.  As a result, the equity-only put-call ratios continue to plunge.  Thus they are still on buy signals, but they are beginning to reach overbought levels as well.

Market breadth was positive yesterday, much more so in terms of “stocks only” data than in terms of NYSE data.  Even so, both oscillators are on buy signals, and in overbought territory.

Volatility indices ($VIX and $VXO) were about unchanged. $VIX hasn’t been declining the past few days, even though $SPX has been constantly making new all-time highs.  It seems that a certain number of traders are still bidding up $SPX out-of-the-money puts (for protection) even as they are buying calls or stocks.

In summary, the overbought situations are now reaching extreme levels (except for $VIX), and so we would expect the pace of the advance to halt for at least a while.  A sideways move, or a sharp downward move, is necessary to relieve these overbought conditions and to set up the market for further gains – if that is to be the path.  In any case, 1623 remains a support level to be watched.

This market commentary was taken from this morning's edition of The Daily Strategist newsletter.