The Dow is trading at one of its most overbought levels in history. At 87.61, its 14-day RSI is higher than 99.999% of historical readings going back to 1900.
Out of 30,914 trading days, that’s good for top 10 all-time.
Sell everything?
If only it were that simple. Going back to 1900, the evidence suggests that such extreme overbought conditions (>99th percentile) are actually bullish in the near term, on average.
Come again? In the year following extreme overbought readings, the Dow has actually been higher roughly 70% of the time with an average price return of 14.2%. From 5 days forward through 1 year forward the average returns and odds of a positive returns are higher than any random day. While the 3-year and 5-year forward returns are below average, they are still positive.
Note: The above table is price only. The returns would be higher if dividends were included.
Does that mean we’ll continue higher today? No, these are just probabilities, and 30% of the time the Dow is lower looking ahead one year.
What it does mean is that one cannot predict a market decline based solely on extreme overbought conditions. Declines can happen at any point in time and “overbought” is neither a predictor nor a precondition of a bear market to come.
If one is going to predict anything based on extreme overbought conditions (and I would advise against doing so), it would be further gains. I realize that doesn’t conform to the conventional narrative of “overbought = bearish,” but the truth in markets rarely does.
