Stocks are Officially Overbought – February 09, 2023
You can feel the excitement in the air. Portfolios are springing back to life.
However, near-term caution is warranted: Stocks are officially overbought.
When you view the world of investing through the lens of data, it’s important to pay attention when warning signs flash. Last week our data signaled some of the largest buying in stocks and ETFs in years. Typically, these rare inflows foreshadow a much-needed consolidation period for markets.
These events are exactly the type of action that can push our Big Money Index into the red zone. As of this morning, we’re officially overbought.
Today, I’ll walk you through the data and show you why history says we’re likely due for a healthy pullback.
But don’t get too bearish! 2023 is setting up to be a strong year for stocks. Near-term downside will likely prove to be a buying opportunity.
Stocks are Officially Overbought
Money flows in waves, swinging from one extreme to the other. Last week I told you how there’s a strong appetite for stocks. That trend has only increased.
Let’s start from the top with our Big Money Index. It tracks unusual buying and selling in stocks.
It guides you to the overall trend in the market. Since October, our data has signaled inflows. But just this morning we’ve breached the rare overbought zone:
In red, I circled today’s action and the last time we went overbought in mid-August. Note how markets fell soon after. Once the BMI begins to retreat, market breadth is deteriorating. That’s the signal to observe. It often prefaces a change in trend.
I also highlighted the oversold signal hitting in October. The past year, the BMI has been a great tool for predicting reversion points once extreme areas are breached…like now.
Diving deeper we can see the daily stock buys and sells powering the trend of the BMI. If the Big Money Index is in the overbought zone, there’s likely ferocious appetite for stocks. There is!
Last week saw the most buying since the post-pandemic rally of 2020. Check it out:
That massive green bar is last Thursday when 456 stocks triggered a buy signal in our data. That’s very rare and represents roughly 30% of our institutional universe logging a buy signal.
Some are calling last week’s action a quant quake, a momentum crash, and a monster short-covering rally. Clearly an event triggered.
Similar action can be seen in ETFs. Below highlights the surge in inflows noted last week:
The recent green bars are last Wednesday and Thursday where 107 and 102 ETFs (respectively) ramped in price on increasing volumes. That usually means retail investors are piling in.
These unusual inflow events are uncommon and point to a near-term pullback.
Let me show you why.
Extreme Stock and ETF Buying and Forward Returns
After Wednesday and Thursday’s wild action in markets, I went back in our history and compiled similar extreme buy days. Since 2009, there’ve only been 19 discrete days where 300+ stocks were bought.
These buy counts are extremely rare!
Below are the forward returns of the S&P 500 post these events. One week later, stocks are down .5%. A month later they’re only up .4%. More importantly, the story gets better when you look out 3 months and longer.
After 3 months, stocks gain 5.8% and a year later they’re up an impressive +12.3%:
I did a similar study with ETFs. I compiled all days where 50+ funds were bought. Since 2010, there’ve only been 35 instances. Like the stock study above, returns are negative near-term and quite positive 6 months later.
Post a week and month after large ETF buying, stocks are down .18% and .22% respectively. Six months out the S&P 500 jumps 8.48%. A year later stocks average a 14.59% gain:
These rare signals often come when stocks are officially overbought. Our message is clear: Near-term be cautious. But also see the opportunity. These pullbacks are oftentimes great moments to go shopping for stocks.
Let’s wrap up.
Here’s the bottom line: Stocks are officially overbought. The Big Money Index is in the red zone. Additionally, extreme buying in stocks and ETFs forecast a near-term pause in the current uptrend.
In our analysis, we will be patient and use a meaningful pullback as a place to pick our spots on high-quality stocks. Odds are [but not guaranteed,] that 3+ months from now, markets are meaningfully higher.
Author: Lucas Downey