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There are rarely this many stocks ‘overbought’ — but usually it’s a good sign

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Just how frothy is the stock-market rally right now?

Consider this stat: Just under half of the S&P 500
SPX
components now have a relative strength index reading over 70, a level considered to be overbought. The RSI is a popular momentum indicator (available on sister site BigCharts) on a 0-to-100 scale that rises as the number, and size, of up days increase.

Andrew Greenebaum, senior vice president of equity product management at Jefferies, said there have only been four other times since 1990 when at least 45% of S&P 500 components have overbought RSIs.

“Despite the fact that an >70 RSI is a trusted signifier of an overbought equity, when it happens to half an index it’s a pretty good sign,” he says.

The 12-month performance afterward was an average gain of 13%, with every instance being positive. In the broader pool of times when at least 30% of S&P 500 companies were in overbought territory — 21 times in the past 33 years — the average 1-month performance was a decline of about 1%, but the average gain over 12 months was 12%.

“The punchline is this: If you jump in at the overbought point, you might get burned; however, this could signal the start of the process toward a fresh [all-time high] for equities,” he says.

S&P 500 futures
ES00,
+0.24%

were higher on Monday, and the Dow Jones Industrial Average
DJIA
has notched three consecutive record highs.

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