The collapse of the market is a terrible sign

During a market crash last Friday morning, a friend sent me an instant message.

“Almost every share I looked at this week was overbought (i.e., the 14-day RSI is above 70) and it’s been over a week. I wonder if there’s a filter we can use to see how many S&P 500 shares there are. (RSI stands for Relative Strength Index, a key measure of a stock’s rate of rise.)
But my friend hit something. In a few minutes I would run the filter in question. He was right: a large part of the S&P 500 was rising faster than ever … At the end of January, about 40% of the firms in the index.
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It made me think. What do the historical fluctuations in the ratio of S&P 500 firms with high RSIs tell us?

What I found is terrible.

A Very Good Thing

Sometimes momentum is a bad thing … too much of it indicates that the market can be irrationally optimist. A historical look at the RSI shows that this is one of those periods.
The Relative Strength Index of stocks (RSI) compares the scale of recent gains and losses over a period of time – with 14 days being the most common. In principle, it measures stocks impulse, up or down.
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Technical analysts use the RSI to assess whether a stock has been over-bought or over-sold. RSI values ​​of 70 or higher indicate that a stock has been overestimated or overestimated and is therefore at risk of correction. An RSI of 30 or lower indicates the opposite – overestimated or undervalued. This can be an opportunity to save.
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The key term is “to be”. Measures RSI speed change in the average price of the stock. When the RSI is high, it means that there is unusual buying activity over a period of time compared to “normal” conditions.
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How big is the RSI Party?

There is nothing unusual about high RSI for private equity. For example, when the market learns that a company is the target of a merger, buyers want to own its shares before this happens, which leads to a high RSI.
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Similarly, when the market thinks that this sector will rise, we can see high RSI measures for a group of shares in the energy sector, for example.

However, given that the S&P 500 has 500 individual firms covering all sectors of the economy, it is not uncommon for a large number of them to enjoy high RSIs at the same time.
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The S&P 500 has had a percentage of firms with an average RSI above 70 in the previous month since 1990. I will call this the “market RSI” level.

The average figure appears between 5% and 10%. However, the RSI level of the market may be higher.

For example, after the recessions of 1990-1991 and 2001-2002, the average monthly RSI of 30% -40% of S&P 500 firms was above 70. This makes sense, because we expect stock prices to rise rapidly. get out of recession.
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In contrast, market RSI levels fluctuate in the range of 5% -10% during long economic expansions, while regular jumps in quarterly earnings reports are about 20%.

Conversely, market RSI levels fall below normal as investors seek other sources of income. This happened during the initial mass supply (IPO) boom before the dot-com bankruptcy and during the 2008 financial crisis, when Americans cheated and refinanced their homes like crazy.
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We Live In Interesting Times

Historically, two unusual situations began in late 2016.

First, every “low” RSI measure on the market is higher than the last. This indicates that the average monthly market RSI is trending higher over the long term. There was no such thing in previous decades.
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Second, the jump in the average monthly market RSI level in January is the highest since the recovery from the recession.

when we passed aa daily The average size of the RSI market level, we see regular fluctuations between about 5% and 25% since the end of 2016.
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But since the end of last summer, we have seen a steady upward trend.

We also see a jump in RSI market levels – up to about 40% – before last week’s big downturn.

RSI: Good for trees, bad for forests

High RSI for individual stocks? Good. For more than one? Dangerous.

Here is my comment. Since the end of 2016, two things have happened.

  • Optimism about Trump’s presidency has blown even small reserves of reserves around such investors in the bull market. As this sunny outlook grew, it snowed – sorry to confuse metaphors – and began the “euphoria” part of the market era. At the end of January, when the average daily market RSI reached about 40%, we reached the peak of euphoria … before reversing last week.
  • Over the past few years, the massive increase in stock trades (ETFs) has distorted the average market RSI by increasing the share prices of “unworthy” firms included in sectoral ETFs. The rising ETF wave lifted all boats … prevented the market RSI levels from falling back to historical norms.

If you look at it from any angle, this is not normal. And if history is a guide, the end will not be good …