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Overbought?

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Is the S&P 500 (SPX) ahead of itself? It depends on what indicator you use. You don't need us to point out how the market recently broke out from its very narrow trading range, but to determine if it is a head fake, maybe we can shed some light.

Using the widely followed 14-period stochastic indicator, the market's seven straight up days has generated an extreme near-term overbought condition (Exhibit 1). This overbought reading would normally be viewed as a good time to chill and wait for a dip to be a buyer. The only problem is other technical indicators suggest the SPX is not yet at an extreme, and may have room to run - regardless of any profit taking that comes into play.

Exhibit 1 - Stochastics suggest an extreme overbought condition...



The MACD (moving average convergence/divergence) indicator suggests the market is well below prior extreme overbought readings (Exhibit 2). What is also interesting is the clear set of higher lows when there are periods of weakness...that isn't typical of markets that are about to get blasted.

Exhibit 2 - ...but the MACD suggests a market with room to rally



In sum, there are very few signs of intermediate-term technical damage or divergences that would suggest a significant decline. Could there be a couple of profit taking days? Sure. For example, the last time the SPX was up seven days in a row was in March. After the eighth up day, the SPX gave up 50 profit taking points and then went up 150 points. Our point is that we accept some profit taking should come into play, but our opinion focuses on the more intermediate-term prospects, which remain solid.
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