Is this market overbought?

When we experience a strong period for the equity markets I get asked by clients and friends if this market is overbought and does that mean we’re in for a sell-off. The short answer is…not necessarily.


One of the indicators I look at is a weekly distribution of the S&P 500. If you remember your Statistics 101 course from college, you’ll recall the normal distribution bell curve concept where the “middle” of the bell curve is where things tend to regress or progress to. We track the ten-week trading band for the S&P 500 and plot it on a graph. What’s interesting is when we look at a period where the band trades at the top of that ten-week trading range. One would think the market would regress back to the mean or middle but that hasn’t always been the case.

Over the past 12 years, the S&P 500 has reached the top of this range 14 times. I looked at how the market performed 1, 3, and 6 months after reaching the top of this trading range. There were only two out of 14 instances where the market had produced a loss after one month. Similarly, there were only two times out of 14 that the market produced a loss three months after reaching the top of this range. And, there was only one time that the market produced a loss after a six month period.

While we never attempt to predict what the market will do, it does help having historical data to help put things in perspective. We will soon be entering another earnings announcement season and as we begin to enter a historically strong period for the markets, it will be interesting to see how things progress.