Is This a "Good" Overbought Condition?

Good Monday morning and welcome back to the game. Well, that didn’t take long. The President doing something controversial, that is. So, with stocks in an overbought condition, it looks like traders have found a reason to do some selling in the early going. And with a decent-sized gap on the chart that needs to be filled, a pullback of sorts was to be expected. But before we get carried away on what to expect next, let’s set aside the subjective analysis and get to the weekly review of my favorite models and indicators.

The State of the Trend

We start each week with a look at the “state of the trend” from our objective indicator panel. These indicators are designed to give us a feel for the overall health of the current short- and intermediate-term trend models.

Executive Summary:

• The board is completely green – that doesn’t happen often
• With most major indices moving to new highs last week, the green is to be expected
• The break to new highs caused our channel breakout systems to get on board the bull train
• The Cycle Composite points higher again next week
• The Trading Mode indicators were struggling to stay positive but are now green again
• The question, of course is if the bears will try to turn the tide in the near-term. For answers we will explore the rest of indicator boards

The State of Internal Momentum

Now we turn to the momentum indicators…

Executive Summary:

• The Momentum board sports a healthy dose of green this week
• However, several of the indicator readings are on the very low end of positive
• The Trend & Breadth Confirm models are not examples
• The Industry Health model is as it flipped from neutral to moderately positive – by a smidge
• The Short-term Volume Relationship model is another example of a barely positive reading
• The good news is the Price Thrust indicator is in great shape
• The other “Thrust” models need more convincing

The State of the “Trade”

Next up is the “early warning” board, which is designed to indicate when traders may start to “go the other way” — for a trade.

Executive Summary:

• As is to be expected, there is a lot of red on the Early Warning board
• Stocks are now overbought on all three time frames: Short-, Intermediate, and Long-term
• However, it is important to remember that during strong bull moves, stocks get overbought and STAY overbought.
• This is why I’ve rated the Short-Term model as “hold” – so far at least, this looks like a “good overbought” condition
• It is also encouraging that our Mean Reversion model has not flashed a sell signal yet
• Ditto for the intermediate-term VIX indicator
• This tells me that things are not “too hot” at the present time – although I’m sure there are many folks that will disagree with me here.

The State of the Macro Picture

Now let’s move on to the market’s “external factors” – the indicators designed to tell us the state of the big-picture market drivers including monetary conditions, the economy, inflation, and valuations.

Executive Summary:

• The bottom line is this board continues to be worrisome
• But before you run out and start buying SPXU, remember that external factors are designed to indicate the big-picture environment
• Also remember that “warnings” from external indicators can be VERY early
• The sell signal from the inflation model tells us that the Fed will likely hike a minimum of 3 times in 2017, maybe 4
• There is no denying that valuations remain stretched
• But… stocks are currently discounting an improved economic/earnings picture. So, the high valuations are not surprising.
• On the other hand, with valuations at lofty levels, any hiccups in the theme could become problematic quickly

The State of the Big-Picture Market Models

Finally, let’s review our favorite big-picture market models, which are designed to tell us which team is in control of the prevailing major trend.

Executive Summary:

• This board sums up my personal view of the market: Things are pretty good, but we must remember that trees don’t grow to the sky
• The Leading Indicators Model remains in good shape. Remember that this model “nailed” the start and end of the mini bear that occurred between August 2015 and February 2016. So, I continue to monitor this closely.
• The State of the Tape Model upticked back into the moderately positive zone. This is a good thing. But… I’d rather see an outright positive reading here at some point.
• The Risk/Reward Model continues to be troubled by the monetary situation and the negative sentiment readings
• The External Factors model is actually on the low end of neutral – and the historical return shows it.
• Important to note that the average return of the market when the board is in the current mode has been double digits. So, it is tough to be overly negative here.

The Takeaway…

The trend is up. Momentum is pretty good. We’ve got a “good overbought” condition on our hands. And there is hope in the air on the macro front thanks to the new administration in D.C. And while I DO believe we need to continue to side with the bulls (and buy the dips along the way), the External Factors board troubles me. From my seat, this tells me that this is not a low-risk, pedal to the metal environment. I believe the bulls will remain in control and there will be money to be made. However, there is risk out there and we need to play the game accordingly. In sum, I believe this is a time to enjoy the ride – but we also need to keep an eye out for trouble!