The big surprise this week is that the S&P/TSX Composite Index is bumping up against technically extended, overbought levels. As of Thursday's close, the Relative Strength Index reading of 64 is close enough to the sell signal of 70 that a strong Friday market session could push the market officially into overbought territory.
There are now only five oversold stocks in the benchmark, three of them from the oil patch. Stimulative measures from China's central bank Friday are expected to support commodity prices so I'm becoming more comfortable talking about energy names. But not comfortable enough to recommend the smaller-cap names that remain on the oversold list.
Thinly covered industrial stock Martinrea International Inc. is a higher risk investment but is our focus stock this week all the same. The stock price has moved wildly in the past 24 months between $7 and $14.
The RSI buy signal has worked reasonably well during the period. A sub-30 reading signalled big rallies in April 2013, December 2013 and March 2014. Buy signals in September 2013 and October 2014 were less successful, followed only by brief rallies before weakness took hold.
This is clearly a case where significant fundamental analysis and stop loss orders are required. For what it's worth, the current average analyst target price of $14 suggests a potential 12-month return of 40 per cent.
There are 28 stocks on the overbought, "investors should hold off on buying any more for a bit," list. Dollarama Inc. is the most technically extended index member followed by Fairfax Financial Holdings Ltd. and Bombardier Inc. Widely held Potash Corp, BCE Inc. , Royal Bank of Canada and Power Financial are also technically vulnerable to a stock price correction or pause.
The RSI readings change quickly – last week's oversold stocks can become this week's overbought – so investors should take the short-term nature of the reading into account. The oversold list had more than 80 members a short month ago and now the list is down to five.
As always, technicals have been proven helpful but fundamental research should be part of every investment decision.
