With the highest RSI reading in over 20 years, what did you expect was going to happen? I understand most new participants might have thought this bull run could continue forever, but any respectable market operator knew they needed to start lightening up in December and January. It wasn’t the question of if the market was going to correct, but when. And, after such a calm bull run since elections, we knew Mr. Market was going to teach any naïve participants a lesson. New participants needed to experience a bit of panic and veterans who became complacent needed a reminder that this market moves in two directions.
The S&P 500 Index ripped in January finishing the month up 5.6%, which was the best start to a new year since 1997. We also closed out the month with another milestone, the S&P 500’s Relative Strength Index (RSI) reading was 87.726. This RSI reading was the highest reading in over the last 21 years. In fact, it was June 1996 when we made that last RSI high of 87.252, the same month Michael Jordon won his fourth NBA championship with the Chicago Bulls and the first since his return from retirement. Other than having another potential dynasty basketball team today in the Golden State Warriors, I do see some similarities specifically between 1996-1997 and 2018. And, just like the 90’s Bulls and today’s Warriors, there are some differences.
Both markets had bouts of volatility shortly after putting in these extreme overbought conditions on the RSI indicator. In 1996 it took two months, but in 2018 it happened days later. They also shared low volatility before the monthly corrections. Prior to the 1996 correction, they had 18 months of calm markets. Likewise, the current market had 15 months of tranquil markets.
The bull run to the RSI reading of 87 in 1996 took 62 months, and the market gained 185% during that time. The run to the RSI reading of 87 in 2018 took 58 months, and the market gained 181% during this time. As you can tell, the numbers are not an exact match, but very similar.
Since the before mentioned facts can be coincidental, we next take a theoretical look at where we might line up regarding the 1996 market. I’ll be honest; I take a stretched out thought and think a bit outside the box to gauge where we might be and where we might be going. Before presenting this hypothetical, let's note, there is always debate about when a secular bull or bear market begins and stops. Some use the absolute top or bottom of secular trends, which would mean 2009 was the start of the new secular bull market. But, I prefer to call a new secular bull market when it breaks above the previous secular bear market highs. That’s my preference.
We broke out of a secular bear market, inflation-adjusted, in March of 1991 that started in November of 1968. Similarly, we recently broke out of a secular bear market, non-inflation adjusted, in March 2013 that started in August 2000. As I mentioned earlier, I’m stretching here, but we did breakout recently on an inflation-adjusted basis as well. It was 25 months later when this occurred in April 2015 when looking at the inflation-adjusted basis. So, slightly different as I mentioned in my analogy in the second paragraph.
The big question is though- where can we go from here? If we look at 1996, it ran another 50 months before topping out, and the market gained another 48% from the volatile July of 1996. That month had a swing of 9.6%, which was a very short-term correction when thinking longer-term. This month we have experienced a 10.3% swing so far, which is close to 1996. I know, I know… We have not yet finished the month, and I easily could be jumping ahead of myself, but in markets, only the future counts. I’m sure there was panic in 1996, just like the millennials experienced for their first time. Unfortunately, I wasn’t able to personally experience this as I was not thinking about the stock market then, but rather more worried about my baseball team standings in Little League. But, we do have sentiment data from AAII back then. Both experienced bullish peaks, but we have yet to experience the lows that 1996 experienced.
I acknowledge there are still many differences that I have not covered and should be taken into consideration when looking at the markets. Markets hadn’t run as far ahead of their earnings trend, GDP averaged around 4% in the mid-90’s, and so on… But, from a technical point of view, there is still a chance and potentially another four years and 48% to the upside. This would bring the S&P 500 to about 4700. I understand this sounds ludicrous, but we all know markets can remain irrational for extended periods of time. Plus, we have yet to see the fundamental impact of tax cuts to earnings and estimates are rapidly rising while the markets have fallen. Time will tell how this plays out, but until then I must continue to believe the market direction isn’t at a massive turning point just yet without a major catalyst. Which is why I’m telling you, there is a chance.