As we are now in the final month of the trading year, some of the top key indices continue to set records. For the month on November, the Dow Jones Industrial Average (chart) finished up 3.48% closing at 16086.41, the tech-heavy Nasdaq (chart) was up 3.57% closing the month at a 13 year high of 4059.88, the S&P 500 (chart) advanced 2.8% in November closing at a record high of 1805.18 and the small-cap Russell 2000 (chart) closed the month of November up 3.88% at 1142.89, yet another record. I think one of the reasons why the markets continue to lift into year-end is that most pundits do not believe that they can. There is not a day that goes by where “bubble” is not one of the top headlines in print, online or on the tube. That said, in my last blog I highlighted the current technicals of the top key indexes and in particular the Relative Strength Index (RSI) technical indicator. Well in the last two weeks or so both the Dow (chart) and the Nasdaq (chart) have now breached the 70 value level with the S&P 500 (chart) and the Russell 2000 (chart) not too far behind. The 70 value level according to one of the RSI principles is an overbought condition. If you go back historically and analyze what typically happens when an index or equity for that matter enters into an overbought condition, the majority of the time a “reversion to the mean“ occurs. Now this is not to say that overbought conditions in an index or stock instantly changes course, however, typically at some point in time a reversion does indeed occur. Now with that said, I have seen indexes and stocks remain overbought for weeks and months at a time before a natural reversion occurs, but it’s something to keep an eye on especially if you have long term gains in your portfolio or if you are a trader and have the gumption to consider a short strategy in this parabolic market.
As this broad rally continues and as we are now in overbought conditions in certain key indexes, one has to wonder what will it take for a “reversion to the mean?” to occur? At this point in time in the calendar year, I am not sure? With only one month left to go in 2013 and with third quarter earnings reporting season behind us, a Federal Reserve that continues to be extremely dovish and fund managers year-end window dressing upon us, whatever pullback (if any) that may occur between now and year-end should be met with anxious support. I just do not see any type of a imminent catalyst that would jar these markets significantly, unless some unforeseen macro/geopolitical event happens, which of course is always a possibility. Should an unexpected negative geopolitical event occur, this in my opinion would be one of the only conditions between now and year end that could create a “reversion to the mean” type scenario that most bears have been waiting on.
Good luck to all 🙂