Canadian investors have started 2013 in a bullish mood but, at least in the short term, they may have gone too far. Technical indicators point to overbought conditions in a large percentage of market sectors.
The Relative Strength Index (RSI), a much-used tool of technical analysis, compares the extent of positive performance days versus down days for indexes and individual stocks. When the RSI rises above 70, an index is considered overbought and prone to a significant correction. An RSI reading of 30 or below signals that an investment is oversold and poised for a snap back.
Four of the nine major subindixes of the S&P/TSX composite index are flashing overbought signals, according to RSI. Industrials, led by Canadian Pacific Railway's 8.4-per-cent year-to-date return, have blasted through the "sell" indicator with a current RSI of 83. Utilities and health care are also well into overbought territory at 77.5 and 75.4 respectively. The S&P/TSX Financials Index, at 71.3, has only just inched into the danger zone.
Materials and Energy remain in safer technical territory, in the mid to high 50s. There are no major sectors with a bullish RSI of 30 or below. Telecom services is closest at 44.2.
Technical analysis is only one part of the investing puzzle and is better suited to traders than longer-term investors. But RSI has been a very successful predictor of short-term stock performance. Investors may want to hold off on new purchases in overbought sectors.