Technical update: overbought, overbullish, declining RSI

We finally have the classic syndrome that indicates an intermediate-term top. Upward momentum has stalled, as sentiment has remained elevated for several weeks. The combination of sideways prices on high bullish readings becomes very bearish when it has been sustained for a month or longer.

Here is the RSI and price picture (note declining trend in the momemtum indicator RSI since late August, and its resemblance to the topping pattern last spring):

SPX and RSI

NDX and RSI
Charts from Yahoo

A quick glance at sentiment shows sustained optimism:
NAAIM
Source: http://www.naaim.org/naaimadsenttrend.aspx

Looking at the headlines, it is nice to see good news that results in a bump with no follow-through. We saw that in mid-September with QE Infinity, and last Friday with the jobs report. Rallies end on good news and declines end on bad news.

It would not be unusual to see another test of the highs, and for prices to linger at these elevated levels for another month or so, but the odds of a sharp decline are now elevated, and any further gains should be quickly erased.

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2 thoughts on “Technical update: overbought, overbullish, declining RSI

  1. Hi Mike,

    Do you think the announcement of QE Infinity marks the peak of the Fed’s ability to boost sentiment and the stock market? Now that Bernanke has committed to indefinite bond-buying and can only increase the monthly amount, has he “fired his last bullet”?

    The announcement of the last few major central bank interventions — Bernanke’s August 2010 Jackson Hole speech signaling QE2; Operation Twist in September 2011; LTRO in November 2011 — came after sentiment had turned very negative and financial markets had sold off sharply. In those cases, it seemed that central bank actions had the effect of supercharging rallies that were already poised to happen based on technicals; and, as a related point, that the occurrence of big rallies starting around the same time as the central bank actions increased market participants’ faith in the ability of such interventions to drive up the stock market. A self-reinforcing loop.

    Bernanke’s remarks in the post-FOMC press conference suggested that he launched QE Infinity early to give the US economy more “momentum” in the hopes of getting over the fiscal cliff in case that turns out negatively (a scenario which Bernanke said the Fed’s “tools are not strong enough to offset”). But regardless of why he did it, does the fact that he launched QE Infinity with the S&P 500 near 4-year highs make it likely that the perceived power of the Fed will be greatly diminished if the stock market declines rather than rallies from here? If that faith dissipates, will the Fed going forward have much less power to arrest declines / goose rallies even if they come up with new substantive tools?

  2. My sentiments exactly on the perceived success of earlier QE rounds – they were initiated when the market was oversold and overbearish and primed to rally anyway. I am surprised that the Fed did not wait to announce this latest round – it seems a waste, since the market was already up and investors were feeling fairly bullish.

    I also agree that the public could lose faith in the Fed if the market falls from here. This would diminish their power to move the markets to the degree that they actually have such power.

    This reminds me of an old Hank Blaustein cartoon from Grant’s, in which the following is overheard at the Fed: “Then it’s resolved – We print more money AND make more speeches.”

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