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Market Significantly Overbought

(March 6, 2002)

The upside continues for the Dow this week, rallying approximately 206 points this week so far to a closing level of 10,574.  The index failed to top the Monday high of 10,586, however.

Let's go straight to the chart:

DJIA Price and NYSE Volume Information (November 1, 2001 to March 6, 2002)

We can't help but think a blowoff is in progress.  An exhaustion rally, so to speak.  The ongoing bull case is that the market could stay irrational for a long time, even though eventually, it will correct.  Moreover, even though volume is still not as high as during the early December rally, volume on up days has been steadily increasing since early February.  The recent rally is certainly suspicious (we maintain it's mostly short-covering) but strictly looking at volume information, there is still no sign of exhaustion and hence, a top in the Dow.

That being said bear market rallies can and will end abruptly and without notice.  The McClellan Oscillator is now over +170, an extremely overbought level-certainly the most overbought we have been this year.  Richard Russell, in his newsletter the Dow Theory Letters, cited that as of the close on Monday, the Dow is "now at the highest percentage distance from its 200-day moving average since August 25, 1987."  The Dow topped out at 2,722.42 on that day, steadily eroding until it hit 2,246.73 on Friday, October 16, and cumulating in a crash with a close of 1,738.74 on October 19 (a.k.a. Black Monday).  We are skeptical about this statistic, but the Dow is now definitely the furthest away (on the upside) from its 200-day MA than at any time experienced for the last nine months.

The U.S. dollar also appeared to have broken down, but the jury is still out.  This is important since foreigners have been financing our current account deficit (to the tune of over $2 billion per day) for the last few years in the form of investment flows.  If this suddenly ends due to the fall in the U.S. dollar, then it would definitely put a lid on the market.  Just this morning, Morgan Stanley effectively issued what amounted to a "sell" rating on the U.S. stock market and the U.S. dollar.

For now, we will just have to ride our the current rally and look for signs of a reversal.  Who knows?  It may have already topped (the Dow failing to close above Monday's close today is not a good sign), but we will just have to see.  That being said, Intel and Sun is on schedule to provide a mid-quarter update after the close tomorrow evening.  Investors' reactions to those reports could be a good prediction of what is to come.  We will keep a close eye on them.

Finally, be sure to check out some important new comments in the just-updated model portfolio.

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