Is SPY Overbought?

by on February 22, 2012 | ETFs Mentioned:

Last year was riddled with volatility across the board as European debt woes took center stage. Despite all of the uncertainty spilling over from the debt burdened currency bloc, U.S. stocks managed to end the year far better than their developed and emerging market counterparts. Nonetheless, resurfacing worries over the health of the global economic recovery have had a lasting effect on investors’ confidence, spooking many into fearing that another recession could sweep over both sides of the Atlantic ocean [see also Five ETFs For Doomsday Capitalism].

At the end of the day however, domestic equities have staged an impressive bull-run since bottoming out in early October of last year, bolstered by encouraging economic data on the home front. With Greek debt negotiations progressing in what appears to be the right direction, many investors are wondering whether bullish momentum on Wall Street can sustain another leg-up as the cloud of uncertainty over Europe slowly evaporates. On one side of the table are investors confident that the domestic recovery can and will overcome any bumps in the road as Europe regains its footing. Likewise, the bears on the other side of the table are worried that the ongoing bull run may be overdue for a pullback, seeing as how Greek debt woes are infamous for resurfacing [see also Why No Investor Should Own GLD].

Fundamental Facts

First and foremost, lets consider where we stand today; the U.S. equity market, as represented by SPY, is up nearly 25% since bottoming out on October 4th, 2011. Economic data releases on Wall Street have been overwhelmingly positive over the past few months, while the situation in Europe has yet to reach a final and concrete resolution [see Fund Managers Turn Bullish As "Risk Appetite" Increases].

Manufacturing data, employment statistics, and expectations for economic growth have all showed evidence that the U.S. recovery is moving along steadily. Since the recent stock market bottom on 10/4/2011, all of the above mentioned economic indicators have been consistently improving. The ISM Manufacturing Index has steadily risen to 54.1 (February 2012 release) from 51.6 in October of 2011, while U.S. GDP has grown from 1.3% in July of last year to 2.8% as of the latest quarterly release on January 27, 2012. Consumer confidence has also improved considerably since the October bottom on Wall Street. The University of Michigan Consumer Sentiment figures has risen from 57.5 up to 72.5 as of the latest February reading. Perhaps one of the most encouraging developments has been the rather significant improvement in the labor market; the unemployment rate currently stands at 8.3%, compared to 9.1% last October.

Despite all of the good news, several obstacles could still derail the bull-train; perhaps the biggest cloud of uncertainty plaguing Wall Street is the looming domestic budget deficit issues. Investors have seemingly brushed aside the debt drama in Washington D.C., although volatility may very well strike again once these unresolved issues resurface and steal the headlines.

Technical Outlook

Consider the 1-year daily chart for the State Street SPDR S&P 500 ETF (SPY) below. As mentioned previously, this ETF has gained close to 25% since its low at $107.43 a share; although the magnitude of this rally may seem a bit overdone given its fairly short time horizon, it’s important to remember that all of the above mentioned fundamental economic indicators have rightfully given investors a reason to be optimistic [see SPY Realtime Rating].

Click To Enlarge

SPY is currently trading above both its 200-day (yellow line) and 50-day (blue line) simple moving averages, showcasing the strength of the ongoing uptrend. When we consider the stochastic momentum index below the volume graph, it appears that SPY is undoubtedly in overbought territory, however, this has been the case since the start of 2012 [see SPY Technicals].

In summary, it seems that SPY has resumed its longer-term uptrend since the recent financial meltdown bottom in March of 2009; this ETF is now back near its 2011 highs and will surely look to overcome this historical level of resistance in the coming weeks. While a short-term correction will be healthy for SPY in attracting new buyers, it’s quite speculative to bet on such a pullback. Traders and investors alike should remember this simple piece of advise: the trend is your friend. Until the fundamentals shift with meaningful price action, it’s better to buy on the dips rather than try and call the top.

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Disclosure: No positions at time of writing.