The chart below is one of several that are included on the second page of our Morning Lineup report each AM. In it, we show where the S&P 500 is trading relative to its 50-day moving average in terms of standard deviations. When the blue line is in the light shaded red (or green) area, it indicates that the S&P 500 is trading between one and two standard deviations above (or below) its 50-day moving average and is at levels that are traditionally considered overbought (or oversold). When the blue line is in the dark red (or green) area, it indicates that the S&P 500 is trading more than two standard deviations above (or below) its 50-day moving average and is at levels that we generally consider to be extremely overbought (or oversold). When the blue line gets above (or below) the dark red (or green) levels…well, that doesn’t happen very often.
As shown in the upper right portion of the chart below, the S&P 500’s current level of ‘overboughtness’ hasn’t happened at any point in the last year. Prior to the current rally, the last time we saw similarly overbought levels for the S&P 500 based on this measure was all the way back in 2004! In other words, kids born the last time the market was this overbought are almost teenagers today! At this point, we were going to make some lame joke about what songs were popular the last time the S&P 500 was this overbought, but we honestly didn’t even recognize any of them. Guess it wasn’t a very memorable time for music!
As mentioned above, the last time the S&P 500 was more overbought than it is now was back in November 2004 following the re-election of George W. Bush. So how did stocks do after hitting those extreme overbought levels? Surely, it pulled back, right? Well, not quite. The chart below shows the S&P 500 during the year 2004. In it, we have included red dots to indicate the two days where the S&P 500 closed at a more overbought level than it did yesterday. While the pace of the advance slowed, the rally kept going through year-end, gaining another 3.9%. Unlike extremely oversold markets, which tend to see imminent bounces, extreme overbought levels do not always result in an immediate pullback.