The signals have 'exemplified a market that is overbought'
U.S. stocks have been on fire in 2018 so far, with the Dow rallying more than 1,000 points in under 10 sessions, and the Nasdaq and S&P 500 Index (SPX) carving out record highs of their own. However, the stock market rally may have gotten ahead of itself, if a recent overbought indicator is any tell.
Last week, 208 of the 500 SPX stocks notched new 52-week highs, according to Schaeffer's Quantitative Analyst Chris Prybal. That equates to 42% of S&P 500 stocks -- a signal we haven't seen since 2013. In fact, since 2009 -- when the current bull market began -- there have been just eight other signals of this kind, and they have "exemplified a market that is overbought," said Prybal.
Stocks have underperformed in the short term after more than 40% of SPX components touched new highs. One week later, the S&P was down 1.05%, on average, and was higher just 38% of the time. That's compared to an average anytime one-week gain of 0.27% for the index, with a win rate of 60%, looking at SPX data since 2009.
Meanwhile, the S&P was higher just 25% of the time looking out two weeks, one month, and three months after signals. The average returns are negative across the board, and are particularly gruesome a month after signals, when the SPX was down 3.67%, on average. Three months out, the index was down 3.19%, on average, compared to an average anytime gain of nearly 3.6%.
Six months after signals, the SPX was down 0.15%, on average, and was higher just 38% of the time. That's compared to an average anytime six-month gain of 6.98%, with a win rate of 83%. However, it's worth noting that the SPX was higher six months after the last three signals, which all occurred in 2013.
If past is prologue -- and considering several sentiment indicators are pointing to an overwhelming sense of optimism on Wall Street -- stock traders may want to exercise caution in the near term. As Schaeffer's Senior V.P. of Research Todd Salamone recently wrote, "I continue to advocate call options to play the upside in this market, as the lower dollar commitment, combined with leverage, addresses perceived risks."