Too Overbought -- For Now

As you know, I am a big believer in patterns. If something has happened in the past, I look for it to happen in the future. It's really that simple.

I don't understand why people like to look for patterns to end, or for the old routine to give way to a new routine. Sports are a great example. The SEC team -- usually Florida -- always wins the BCS championship, so my money is with Florida on Thursday. Last year in the NBA finals, the Lakers never covered against Boston. Not once in six tries, so why keep looking for the Lakers to cover? Philly beat the Giants in New York a few weeks ago, and I am taking them on Sunday to keep it close or win again. Otherwise, the home teams should all win this weekend. So there's the sports analogy.

In the stock market it's the same thing. Most recently we experienced the "Santa Claus Rally" that I had discussed over recent weeks (beginning in my column on Dec. 10 ). The market almost always rallies from Christmas into year-end and early January. That's the Santa Rally. Why bet against it? This year produced the sharpest percentage gain in that pattern in over 70 years -- the S&P 500 was up 7.4% for the seven-day pattern that ended Monday. If you weren't long the market for that move, you should ask yourself, "Why not?"

But now things have changed somewhat, as that strong seasonal pattern is behind us and the market has come a long way in a hurry. The market is now as overbought as it has been in years, and according to some indicators it is the most overbought it has ever been. The McClellan Oscillator has not only produced another new all time high, but now it has made a series of three consecutive all-time highs, culminating in yesterday's new record reading of +386.3. At least according to this indicator, this is the most overbought the market has ever been. That has to produce some caution flags.

---

At the time of publication, Schiller was long SPX, Russell 2000, NDX and financial services mutual funds in a range of 15% to 30% levels; short SPY February call spreads; short bond funds up to 5% levels.

Dr. Harry Schiller is a Registered Investment Advisor with the California Dept. of Corporations. He holds a Series 7 General Securities license as well as a Series 4 Options Principal license. He has been owner and editor of the Short Term Consensus Hotline since 1988. For more information, see www.harryschiller.com. Under no circumstances does the information in this commentary represent a recommendation to buy or sell stocks. While he cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.