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Is The Market Overbought?

Posted by Larry Doyle on April 1, 2009 9:55 PM |

A few weeks ago, I wrote a piece on whether the market was oversold. Allow me to re-introduce a few topics . . .

The market valuation of any asset is determined by three factors:

1. Fundamentals: measures items such as cash flow analysis, cost-benefit analysis, earnings before interest, taxes and depreciation (EBITDA)

2. Technicals: measured by regression of price movements to determine overbought and oversold conditions

3. Psychology: measured by unscientific surveys of market participants

And now the update:

1st quarter earnings are due out over the next few weeks. Most analysts and managers I follow believe these earnings will be lower than expectations and that 4th quarter 2008 earnings will be revised lower. Will companies provide guidance going forward? Many companies have refrained given the economic uncertainty.

Differing technical analysis has the market now in the early stages of being overbought, but not dangerously so.

Psychology is also becoming decidedly bullish.

Add it all up and we have markets that have rebounded from an oversold condition.  We have experienced a very sharp rally, but risks remain very high. Economic clouds remain on the horizon.  My personal belief is that the market will retrace to the 7100 level on the DJIA. That 7100 level represents a Fibonacci Retracement level I wrote of on March 6th. Much as we traded around the 8800 level (another Fibonnaci number), I would now not be surprised if the 7100 becomes the center of another trading range. Markets can correct overbought or oversold conditions by corrective price actions or by marking time with sideways price action (effectively running in place).

On the psychology front, I think it is beneficial to review an unscientific survey called the Blogger Sentiment Poll managed by one of our Economic All-Stars (see left sidebar) Laszlo Birinyi. This survey comes out weekly (although Laszlo missed a few weeks) and measures respondents’ bullish, bearish, and neutral outlooks. For comparison purposes, I have compiled a chart of Birinyi’s survey from the last several weeks. The bullish measures have moved sharply higher, and bearish sentiments sharply lower. 



The Blogger Sentiment Poll is targeted at active market participants. Based on my experience, a lot of these surveys run together. Back on February 25th I said “unless and until I see measures of bullishness approach the 25-30% area will I believe the market is oversold.” Well, as we can see with the moves of the last three weeks, the market rebounded solidly from an oversold condition.

A mere 3 weeks ago, further evidence of an oversold condition was provided in a Bloomberg story, Stock Market Bears Grow More Convinced 17 Month Rout to Deepen. A major bullish barometer in this piece registers in at a paltry 29%!!

What do we learn from polls and stories such as these?


I’ll be watching. Any questions? Don’t hesitate to ask!!


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