Why the stock market is becoming 'very, very overbought' into year-end

The Dow, S&P 500 and Nasdaq all closed at record highs on Monday based upon one thing: the prospect of the U.S. tax bill passing. Now, we're entering into precarious territory.

The tax bill is also getting most of the credit for the rallies in most of the overseas markets, too. The reason I highlight this is because the domestic stock market is becoming very, very overbought.

Here's one example. The S&P 500's weekly relative strength index is now extremely overextended, at 83.4. Additionally, the S&P 500 is now trading at a 25 percent premium to its 200-week moving average; this is very close to where it touched in 2007.

Therefore, the market is becoming very vulnerable to a "sell the news" reaction once the bill is actually passed. With only two weeks left in the year, the stock market just might be able to push off any "sell the news" reaction until after Dec. 31. Either way, the market is getting vulnerable to a near-term pullback that would work off this overbought condition.

However, our thinking right now goes like this: Whether the market can rally further in 2018 will be based on whether several key groups — banks, energy, and health care — can push above some key resistance levels, and thus provide some broader leadership to give us another leg higher in this rally.

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Correction: This story was revised to correct that the S&P 500 is now trading at a 25 percent premium to its 200-week moving average.


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Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's Closing Bell (M-F, 3PM-5PM ET). In addition, he contributes to CNBC and CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

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