Investors Are Becoming Optimistic (Not Good)

Optimism Is Here

I’m strongly in the camp which expects the S&P 500 to break its all-time high opposed to forming a double top. I’m not big on technical analysis, but that would be a scary chart pattern if it occurred. However, even though I’m still bullish on the stock market in the near term, it doesn’t mean I ignore the potential negative catalysts of a correction. In this case, I’m referring to a correction in the recent upward move, not a return to the February low. Optimism is returning to equities which is a bad sign in the near term. Whether is at extreme levels depends on the indicator you review. Clearly, extremely bearish sentiment is no longer a catalyst which can push stocks up.

Relative Strength Index Highest Since January

The relative strength index peaked at 86.09 when the stock market peaked on January 26th. An overbought signal is anytime the RSI stays above 70. Clearly, the market can stay overbought for a while because it was over 70 for almost all of January and frequently was above 70 in 2017. The indicator bottomed at 27.98 on February 6th as it wasn’t at the oversold point, which is below 30, for long.

When you pair technical analysis with a fundamental understanding of earnings and economics, it’s a winning proposition. Because earnings and the economy are strong, it’s reasonable to expect the bull market to continue which means the market will be overbought much more often than it’s oversold. Currently, the RSI is at 66.16 which is the highest point since the correction. The good news is the last time the S&P 500 was at the current price, the RSI was higher. If the S&P 500 makes a new record high, I expect it to do it at a lower RSI, meaning the level is less likely to inspire selling.

Two Investor Sentiment Surveys

As I mentioned, the investor surveys have begun to show optimism. The chart below shows the AAII survey has become much more bullish in the past couple of weeks, but it’s not close to any of the peaks reached when stocks became overheated in this bull market. It’s amazing to see how many mini sentiment cycles have occurred in this bull market because of its length.

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