Are Equities Oversold?

February 09, 2018

After an extended period of historically low volatility and steady gains in U.S. equity markets, the first significant pullback for U.S. equities since February 2016 has transpired over the last week. Through February 8th, the DJIA and S&P 500 each traded below their January 26th all-time closing highs by 10.4% and 9.7%, respectively. In 2017 the DJIA posted a record 71 new closing highs while the S&P 500 notched 62 new closing highs, its second highest in history. The upward trend continued into January 2018 with both DJIA and S&P continuing to record 11 and 14 additional new closing highs.

With the sharp return of volatility to a bull market that is already long in duration, investors are rightfully feeling a bit jittery right about now. The catalyst for the recent sell-off began with last week’s employment report showing faster than expected wage growth. This created concern that inflation could rise faster than expected. Under this scenario, the Fed would be forced to raise short-term rates at a quicker pace than what is currently being priced into the market. Only time will tell if this was simply a long overdue pullback as part of a normally functioning market, or the start of further price deterioration. While the bull market is long by historical standards and valuations are near the upper end of their historical ranges, economic and corporate fundamentals do not appear to signal warning signs. With such uncertainty, it can be helpful to look towards technical signals for clues.

This week’s chart looks at a popular technical indicator, the Relative Strength Index (RSI). This indicator measures the degree of recent gains and losses for a security or index over a specified period, typically 14 days, to identify overbought or oversold conditions. Its calculation captures both the speed and magnitude of price movements. RSI values range between 0 and 100, however RSI values of 70 or above are generally considered overbought and likely to experience a trend reversal. Likewise, RSI values of 30 or below are generally considered oversold and likely to experience a trend reversal to the upside. RSI values can remain in overbought or oversold territory for extended periods of time, so it is not until that value crosses these threshold levels again that a bottom or top is considered as being potentially formed. At the January 26th close, the DJIA’s RSI measured 88.7 and had been in overbought territory since late 2017. With the recent pullback, the DJIA’s RSI quickly dropped to 29.5 as of February 5th. The following three trading days produced large price swings, but ultimately these indices have continued to trade lower. Currently at 30.4, RSI for the DJIA is thus far holding above the oversold threshold. While a technically oversold level may foreshadow a future potential uptrend, investors should not place too much weight on any one indicator.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.