Market Looks Overbought Short Term, Longer Term Could Be More Promising

Historically, the equity markets have been known to experience some of their largest declines in the month of October. Equity market returns in the just completed October did not fall prey to this statistic though. The S&P 500 Index and the Dow Jones Industrial Average had their best monthly returns in four years, both up by more than 8%.

From The Blog of HORAN Capital Advisors

Source: Advisor Perspectives

The recent strong equity market returns have pushed the market into short term over bought territory. However, looking at longer term technical indicators the market and its technicals resemble the October 2011 time period.

First, looking at shorter term technicals, the below daily chart of the S&P 500 Index shows the index's MACD and stochastic indicators have moved into overbought territory. Both indicator levels are similar to levels reached in October 2011. The market return subsequent to 2011 has been resilient.

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In comparing the same indicators on a weekly chart though, one can see the October 2015 and October 2011 levels are nearly identical as well with the MACD indicator experiencing a bullish crossover at both dates.

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In terms of individual stock movement, the below chart shows nearly 80% of S&P 500 stocks are trading above their 50 day moving average as of Friday's market close. In comparison, at the end of August, only 5% of stocks were trading above their 50 day moving average.

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Only 52% of stocks are trading above their respective 150 day moving average. This is certainly an improvement over the 13% level in late August. The current level though remains below prior peaks in the mid 80% range.

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Lastly, the 21-day moving average of the equity put/call ratio is now trending lower and stands at .68. Near the end of September, we noted in a post, A Few Positive Equity Market Technicals, that the moving average of the P/C ratio appeared to peak around .79 and was beginning to turn lower. Equity put/call ratios over 1.0 are indicative of oversold markets. By looking at the 21-day moving average of the P/C ratio, a potentially more sustainable trend can be seen. Declines in this ratio are generally associated with a market that trends higher on a forward looking basis.

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A significant difference between 2011 and 2015 is the earnings growth of S&P 500 companies. In 2011 operating earnings were growing at a double digit rate. Today, as the market digests third quarter corporate earnings reports, earnings growth is expected to be negative on a year over year basis. Secondly, the Dollar:Euro exchange rate was nearly $1.40 in late 2011 and now the exchange rate is $1.10. This Dollar strength is serving as a headwind for multinational companies. We expect further Dollar strength; however, not of the same magnitude as experienced from 2011 to 2015.

In conclusion, the equity market does appear overbought in the near term. However, in evaluating longer term technical measures, the market appears to want to move higher in spite of the potential for a short term pullback. As we have noted in several recent posts and our most recent Investor Letter, for reasonable equity market returns to be achieved over the next twelve months, a lot will hinge on earnings growth in the fourth quarter and first half of 2016. At worst, the currency headwind should lessen and the consumer should benefit from lower energy prices.