The Signal That Called the 1Q Plunge Just Went Off Again

As fear re-emerged and traders exercised caution ahead of today's highly anticipated Fed decision, the number of S&P 500 Index (SPX) stocks in "overbought" territory -- defined as a 14-day Relative Strength Index (RSI) at or above 70 -- recently fell to zero. However, according to Schaeffer's Senior Quantitative Analyst Rocky White, this relatively rare occurrence tends to precede short-term bouts of bearish price action.

Specifically, the "signal" went off on Sept. 14, one week prior to the big Fed and the Bank of Japan's (BoJ) reveals. Going back to 2010, there have been only nine other times (using a 30-calendar-day spread) that "overbought" SPX components were nil, the last of which occurred on Dec. 31, 2015, just before stocks went on a massive selling spree to the February lows.

In fact, the S&P was down 6% a week after the last signal, and was 8% lower going two weeks out. The index was still down a hefty 6.9% one month later, in early 2016, but eventually recovered to notch three-month return of 1.1%. 

However, it was just the opposite after the Aug. 24, 2015 signal, which marked a bottom for the S&P. The index bounced more than 4% in the subsequent two weeks, and was a whopping 10.4% higher looking three months out.

On average, though, a "goose egg" in the number of "overbought" stocks spells trouble for the S&P. The index averages a loss over the next two weeks, compared to "anytime" gains, going back to 2010. While the SPX tends to be positive going out one and two months after a signal, the returns are much lighter than usual, too, as is the percent positive.

In conclusion, not only is the Fed decision in and of itself typically a precursor to short-term bearish price action, but so is a lack of "overbought" stocks, it seems. What's more, the recent spike in weekly buying climaxes -- which hasn't happened since 2014 -- also tends to be ominous, not to mention we're in the midst of the weakest week of the year, historically. But, as long as the SPDR S&P ETF (SPY) stays above this key level, the long-term bull case remains intact, per Schaeffer's Senior VP of Research Todd Salamone.

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