IRA Investing: Beware of False Optimism

The problems facing the U.S. economy remain very clear. Declining real estate values coupled with increasing commodity prices have put the consumer in a very precarious position. The solutions to these problems are elusive.

I must confess that I have not seen anything coming out of the administration or Congress that gives me any comfort that the politicians are going to provide any solutions. On the contrary, discussions about windfall profit taxes and the passing of a bloated, earmark-laden farm bill indicate to me that our elected representatives are clueless.

I wish I could be cheerier about the market's prospects as outlined by my indicators, but they have continued to deteriorate during my three-week absence. It's the same old story. The recovery rally since March engendered too much speculation and a general feeling by speculators and small investors that the worst was over. For example, the ratio of Nasdaq volume to NYSE volume started to expand again and never did reach levels that could even be called neutral. This indicator remains extremely bearish.

Other indicators have also slipped into the bearish camp. The ratio of total odd-lot sales including short-sales to odd-lot purchases is now bearish, indicating that these small investors are too optimistic about the future. Similarly, money flows into bullish Rydex funds are too high compared with flows into the bearish funds, and this indicator is also now bearish.

Confidence levels of smart investors compared with the confidence of dumb investors as measured at sentimentrader.com have declined and are now rated neutral. Also continuing at neutral is the ratio of odd-lot short sales to odd-lot purchases.

Click here for larger image.

Last week I lost my last bullish indicator. Let's look at that indicator now.

This is a five-year chart of a 10-week average of the equity put/call ratio on the CBOE, shown in red. The data have been adjusted to compensate for the slowly increasing trend in this ratio over time. The S&P 500 is shown in black, and the green trend lines relate to the indicator's average and its standard deviation.

This indicator reached extremely bullish levels in March and correctly forecast the rally in the market from price levels recorded at that time. Now, though, the ratio has declined sharply and is no longer in the bullish range. It was my last remaining bullish indicator, but is now just rated neutral.

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At the time of publication, Moore held HP, CPX, SGY and USPH in a retirement account, although positions may change at any time.

Richard Moore, CFA, has 40 years of experience in various facets of the investment business. He has been employed by banks, mutual funds and investment advisory organizations during his career and has also owned retail and service businesses. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Moore appreciates your feedback; click here to send him an email.