A major warning signal just flashed for the stock market – Markets Insider

red warning lights signal sirenWikimedia Commons

For months, stock market pessimists have been saying that US equities are overvalued.

And, as of this past week, they have a major piece of tangible evidence.

The measure in question is the so-called relative strength indicator (RSI), which indicates when the stock market has gotten too stretched in either direction. When the measure exceeds 70, that means it’s overbought, and a downturn may be imminent. Meanwhile, a drop below 30 for the RSI indicates an oversold condition.

The RSI for the benchmark S&P 500 climbed above 70 last week, and stayed in that overvalued territory for five straight days. Now, the index’s repeated climb to new record highs is in danger — at least if the past 12 months is any indication.

spx rsiThe RSI on the S&P 500 is above the 70 level, signaling that the index is overbought, and suggesting that a rocky road could be in store. Business Insider / Andy Kiersz, data from Bloomberg

Late last year, the indicator climbed above 70, before peaking on December 13. The S&P 500 was almost entirely unchanged over the next month, slamming the brakes on the momentum that had seen the benchmark surge in 2016 up until that point.

More recently, in early March, the RSI on the index once again found itself peaking above the 70 level. The S&P 500 would drop 1.4% over the next month, despite a 5.6% year-to-date climb through the end of February.

But this is not to say the 8 1/2-year bull market as we know it is in danger. After all, the past two instances of overstretched conditions in the past year have resulted in more of a consolidation period, rather than a full-fledged selloff.

What it does do is provide investors with a reality check — that contrary to recent returns, the stock market doesn’t always climb in unstoppable fashion. Adding to positions, especially at these expensive levels, may not be worth the trouble for those looking to put more money to work — at least for the time being.

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