Have Stocks Gone Up Too Much?

The more things change, the more they stay the same. This time is no different.

Despite the steady rise in US equities since 2009 investors and traders are still trying to pick a top thinking that stocks have “gone up too much.”

Whatever those reasons may be, the objective, observable price-based information conveyed by the market tells another story.

Large Caps

Looking at a monthly chart of the S&P 500 (SPX) we can see how the price advanced steadily over the past six years.

Currently, there are observable bullish technical indications from a long-term perspective. For example, SPX has pushed its Relative Strength Index (RSI) into overbought territory and held that level for most of 2017, indicative of a very strong market.

Additionally, the Moving Average Convergence Divergence (MACD) displayed a bullish crossover at the end of 2016 and has sustained a bullish tone since.

However, the most telling and interesting indicator in the chart at hand may be the Average Directional Indicator (ADX). ADX is a trend indicator that identifies trend strength independent of direction.

As of September 2017, the monthly ADX of SPX posted a reading of 25.19. Typically, ADX levels over 25 indicate a strong trend is emerging or resuming after consolidation. Seeing as how ADX has spent all of 2017 advancing from trendless readings around 15 to 25.19, the current trend in SPX may be just starting.

Moreover, coupling the Directional Movement Indicator with ADX shows +DI over –DI indicating that an uptrend is has been built by SPX since late 2016.

Accordingly, investors will be best served to stay long SPX until provided with a reason to sell.

Small Caps

Elsewhere within the US equity market, the Russell 2000 (RUT) which represents small-capitalization US companies, is offering confirmatory evidence.

This week RUT broke out to the upside of a 10-month consolidation zone. Price behavior like this is a sign of strength that should be bought.

Moreover, it is typical that a large base or sideways period in a market is followed by a long, extended move in the direction of the breakout.

However, since RUT is very overbought based on RSI and the price has traveled nearly uninterrupted since mid-August 2017 to its current level in late September 2017 its momentum may wane in the short term.

Despite RUT making new highs over the past year these levels are unconfirmed by monthly MACD. Typically, non-confirmation is a sign of a lack of follow-through for a market. However, since this is from a monthly perspective any move that conflicts with the uptrend will take time to materialize.

Accordingly, even though RUT broke out to new highs this month investors should watch for any divergence unfolding that could signal an impending change over the months and years to come.

Conclusion

If the concerns about stocks being too high are relevant, the market will begin to reflect the facts in its price action.

Whether right or wrong, the market has already thought of every concern from every angle we can conceive.

By avoiding the common missteps of forecasting, watching the markets too closely, comparing to what others are doing, or waiting for the next pullback traders will be able to extract as much return from this trend while it lasts.

John DiRico is a trading and investment professional focused on technical analysis as well as alternative investment strategies. Additionally, he is the founder of the blog “A Discounted View” where he offers his observations on markets based on industry experience and topics covered in the Chartered Market Technician (CMT) curriculum. Please feel free to connect.