The S&P 500 is in a bull market, whichever way you look at it. Having suffered a short and shallow bear market between May and October 2011, it has since re-entered a full-blooded uptrend. Not only has it accomplished a gain of 20 per cent – fulfilling one basic definition of a bull market – but it has also just this week surpassed its previous high in May 2011 at 1371.
There is still a great deal of scepticism over this bull market's prospects, though. In some way, I can't blame the cynics, either. I see the whole thing as a giant reverse maelstrom set a-swirl by the central banks. But I am not into swimming against such powerful tides. I have been dutifully going with the flow pretty much ever since the October lows last year.
I've heard quite a few investors whom I respect suggest that the S&P is heading for some sort of significant top before long. But I just can't see it that way. There are few, if any, of the symptoms that typically accompany a major peak. That's especially the case for the weekly relative strength index (RSI), which I find is one of the most useful tools for determining the stage of a larger trend in the stock market.
The relative strength index was invented in 1978 by Welles Wilder. It shows the state of momentum in a market by comparing how many times a price has closed higher and lower during a certain period, and by how much. The scores it generates run from 0 to 100 per cent. With the S&P's weekly RSI, I would regard a reading of more than 70 per cent as overbought and less than 30 per cent as oversold.
In a bull market, the typical pattern is for the weekly RSI to make a high some way ahead of the S&P itself. This is sometimes referred to as "bearish non-confirmation". Going back to the 1920s, bearish non-confirmation has happened in 15 bull markets out of 17. At its peak, the RSI has reached a median reading of 78.6 per cent. Only once did it fail to get above 70 per cent, and that was during a miserable excuse for a bull market in the Great Depression era. The RSI peak occurs a median 371 days before the S&P itself tops out.
Even at this week's new highs in the S&P, the weekly RSI was only at 63.5 per cent. It would be a pretty funny bull market that ended with such a low reading. I would at least look for the index to notch up a slightly overbought reading above 70 per cent before I'd really be contemplating an end to the action. Once such an overbought number has flashed up, the final peak in the S&P's price normally occurs with a reading around 67 per cent.
History, then, has a clear message for traders and investors here. Wait at the very least for the S&P's weekly RSI to get above 70 per cent. And then consider waiting for the index to experience bearish non-confirmation. With neither on the horizon for now, my medium-term outlook for this index is firmly bullish.