The Nasdaq has performed well one month after landing in overbought territory
The Nasdaq Composite (IXIC) is on pace to end the month in overbought territory, according to its monthly Relative Strength Index (RSI) reading. The RSI is a popular technical analysis indicator available on practically all charting software. It is an oscillator that ranges from zero to 100; a reading of 70 or above is often considered overbought, while a reading of 30 or below is often considered oversold. Recently, I did a study on how the Nasdaq, as well as the S&P 500 Index (SPX), has performed in the past following a cross into overbought territory based on the monthly RSI.
Nasdaq Now Overbought
We have data on the Nasdaq going back to 1971, and in that time there have been 18 occurrences of the index's monthly RSI crossing above 70. I only considered instances when it was below the level for at least the prior three months. The table below summarizes the Nasdaq returns after these occurrences, while the second table shows typical returns since 1978 -- the year of the first signal. Based on this, the Nasdaq has typically performed well over the next month, with an average return of more than double the typical return; and 67% of the returns positive versus the usual 61%. After that, however, the index has stalled. The three-months after a signal has underperformed its usual return, while the six and 12-month returns aren’t much different from normal.
S&P 500 Not Overbought Yet
The SPX hasn’t run up with the same veracity of the Nasdaq, so its RSI isn’t as high as the Nasdaq. It’s right around 60, but climbing. I gathered the data going back to 1950 on when the monthly RSI on the S&P 500 crosses above 70.
For the S&P 500, the RSI looks to give a more reliable overbought signal. The index underperforms going forward at each time frame I looked at. As you can see in the table below, a year after a signal, the SPX averaged a gain of about 5% with 54% of the 26 returns positive. Typically, the average 12-month return for the index was 8.8%, with 74% of the returns positive. The one, three and six-month returns after a signal all have a lower average return than the typical return, with a lower percentage of positive returns as well. When the monthly RSI gets to the overbought level on the S&P 500 Index, it might be time to expect less from stocks. That’s still at least a month away and probably more.
