What’s Gone Up Must Come Down

Listen to this post

Investing over the last two months has felt a lot like trying to break the laws of physics.

Think of it like this…

Imagine trying to hold a beach ball underneath the water… forcing it down below the surface.

Then, when you let the ball go, it shoots out of the water in spectacular fashion. Everyone nearby laughs and cheers.

Stocks acted just like this. They got so beaten down, so hated, so feared… that the financial laws of physics could no longer tolerate the pressure. Prices had to bounce back — hard.

It should be no big surprise that all the losses from September through October have reversed, and then some. The Dow and the Nasdaq have both closed at record highs. All is well… and speaking from personal experience, it’s a particularly rich-feeling holiday.

But lest we forget… the laws of physics cut both ways. So now, what’s gone up must come back down.

A pause is in order, probably even overdue… And that’s reflected in the late-afternoon dump in the markets on Wednesday.

At least, for most stocks.

One market we’ll talk about — one that hasn’t participated in the beach-ball act — is finding its footing. And this sector may be one of the big moneymakers next year.

Plus, if you’re wondering what to buy and avoid in 2024, keep on reading to the end of today’s issue. We have something very special in store for the holidays: a 100% free event full of investing ideas you can’t afford to miss.

As always, we’ll get there.

But we can’t talk about any of that before we make sense of this pesky “overbought” situation…

❖ There are a lot of ways to check for overbought conditions…

And you need to look from multiple angles — not just one. Here’s what I mean.

This is a daily chart of the S&P 500 going all the way back to 2020 with a popular momentum indicator, the Relative Strength Index (RSI), at the bottom. That white line on the RSI shows the recent peak of the indicator — we reached the most overbought level in over three years.

So yes, stocks are overbought. Wickedly overbought. Moreso than the top of the decade-plus bull market that ended in 2022.

…On this one time frame.

The daily view is useful for looking at short-term momentum conditions, but it’s not the entire story. That won’t stop the mainstream media from blasting out articles about overheated technical levels, of course.

So let’s take a longer-term view, using the weekly chart: Weekly charts use data plotted once per week, rather than once per day. Using these charts gives us a much longer-term view of the market’s momentum.

With this perspective, we start to see a different picture. I’ve left the white line from the daily chart in place on a weekly chart, above. We can see that stocks, from a long-term perspective, actually haven’t even escaped into overbought territory yet. You have to go all the way back to January 2018 for a higher reading.

Granted, stocks have had a tendency to back down sooner from overbought conditions on this time frame, but not always. In the chart above, you can look back to February 2020 to see what a truly overbought level is on this time frame. Even without the pandemic hitting the next month, stocks were bound to pull back significantly.

My point is, on a much longer-term basis, the recent gains in stocks are really not too out of the ordinary. That leads me to believe that conditions could stay relatively overbought for quite some time.

One last thing: check the divergence between the price and the weekly RSI (which I’ve underlined in blue) back in 2022. While the RSI was making a higher low, stocks were making a lower low. That one small thing marked the end of the 2022 bear market. That’s a valuable signal to note.

Keep these ideas in mind whenever you hear about RSI analysis. Context is important in all things, and especially markets. This “technical context” shows the true story.

My takeaway is that stocks will probably continue to take a breather through the end of the year, and that’s OK. Given the long-term context, those will be dips to buy.

Enough about RSI… Let’s look at a real mixed bag of a rally…

❖ Oil prices are back on the upswing…

And it’s thanks to… wartime piracy?

Iran-aligned Houthi militants attacked several vessels in the Red Sea this week, disrupting shipping routes. Oil and gas giant BP (BP) suspended all operations in the area, driving oil prices 2% higher this week.

We haven’t seen such a disruption-driven price movement in oil since the beginning of the Israel-Hamas conflict, and before that the Russia-Ukraine conflict.

Oil investments enjoyed a week of relief from this event… But what’s even more important is that it proves, yet again, just how volatile the global energy trade is under wartime conditions. A seemingly small conflict can drive tremendous change — and price movements.

Regardless, energy stocks have simultaneously been among the cheapest (trading at just 8.5 times earnings) and most hated in the market. That makes them prime pickings for against-the-grain speculators and value investors.

While I do have quite a bit of egg on my face for being so bullish oil a couple months back, I’m not turning tail. I added to my favorite energy holdings in the recent weakness, to counterbalance the riskier growth side of my portfolio. These investments will pay dividends, literally and figuratively, next year and beyond… But oil’s not the only sector worth watching in the new year… And you’re going to hear all about what we think are the best ones to own.

❖ The 2023 TradeSmith End-of-Year Roundtable starts this Sunday…

And it’s one of the most value-packed stretches of financial publishing we do all year.

From Dec. 24 through Dec. 30, we’re bringing you the top insights from the brightest and best minds in the TradeSmith network.

All of them will share their ups and down from the past year, and look forward to 2024 to show you which sectors you should look to buy into… and which to avoid… to make the most of what’s coming.

And as a special bonus exclusive to TradeSmith Platinumsubscribers, there’ll be a specific investment recommendation to take advantage of each analyst’s forecast.

You’ll hear from TradeSmith every day in your inbox, you’ll receive a new video from Mike Burnick, Jason Bodner, John Jagerson, William McCanless, and many more.

And you’re getting this 100% free. Just stay tuned to TradeSmith Daily and you’ll get everything on offer.

For tomorrow’s Profit Column, I’ll bend tradition and send you a very special interview with the man who, day in and day out, makes TradeSmith the incredible place it is.

I’m looking forward to sharing it with you, and I hope you’re looking forward to seeing it.

And as one final note, our offices will be closed for an extended holiday period, from Friday, Dec. 22, through Monday, Jan. 1. Have a wonderful holiday and Happy New Year. We look forward to helping make 2024 another great year for you and your loved ones.

To your health and wealth,

Michael Salvatore
Editor, TradeSmith Daily