The see-saw continues. The S&P/TSX Composite jumped 3.4 per cent in the five sessions ended Thursday and is now very close to oversold, technically extended territory according to Relative Strength Index (RSI).
There are only two oversold stocks by RSI this week, Manitoba Telecom Services Inc. and Genworth Canada Inc. Both bucked the trend with a terrible week, falling 9.2 per cent and 5.8 per cent respectively.
I don't want to focus on either one of these stocks at the moment. In both cases, the forward price earnings ratio is higher than the trailing PE, which means that analysts expect profits to decline on a year over year basis in 2015.
This leaves the S&P/TSX Composite benchmark itself. The effectiveness of RSI in gauging the future performance of the domestic equity market has been reasonable but has changed in recent months. From October 2013 to August of 2014, the RSI sell signal of 70 was effective, but the subsequent corrections were extremely small.
In hindsight, it's clear that investors should have started taking the sell signal a lot more seriously starting in late summer 2014. The sell signal on August 27 and the near-miss in late November (RSI hit 65 on November 20) were followed by big, painful craters in equity prices.
The current RSI reading of 67 is bumping up against the 70 sell signal. This is above the late November peak but that doesn't mean another 9 per cent drop is in store. But given the extreme levels of volatility in equities in the past few months, I do think investors should be cautious in the coming days.
Thankfully, the RSI is based on very short term data and changes quickly. The TSX could be far less frothy in just a few days.
As always, investors should know what they're buying - technical analysis should always be accompanied by fundamental research before any market action is taken.
