IRA Investing: Indicators Continue to Improve

Another difficult week has passed, leaving me thankful for a hefty cash position even though the money market rate I'm earning is less than the inflation rate. It looks as though the credit problems are spreading into other areas of the economy, such as regional banks and credit card debt. As has been the case for many months, the ultimate scope of these problems is hard to define, and I don't believe the market can make sustainable progress until the worst is discounted.

Of course, I could take the obvious path of least resistance and invest all my assets in energy and other highflying commodities. In fact, I think that is exactly what many investors are doing. However, the risks in taking this approach are very large, and I think before this market unpleasantness is over, the commodity bubble will burst.

My indicators continue to improve modestly, but so far none has turned bullish. The most bearish indicator continues to be the ratio of Nasdaq volume to NYSE volume, as it remains at a high level. It shows some signs of beginning to decline, but the increased speculative activity taking place in recent weeks needs to subside before we can even take this indicator to a neutral reading. Actually, the recent superior performance of tech stocks could be a sign that this area will be a market leader in the next bull move, but in the later stages of a correction or bear market, these higher-risk stocks will probably suffer.

All my other indicators are now neutral. The ratio of odd-lot short sales to odd-lot purchases is stuck in neutral territory and did not increase last week in spite of the market weakness. The equity-only put/call ratio was a bit higher last week but is still neutral. The spread between the confidence levels of smart and dumb investors is definitely improving, primarily because dumb investors are becoming very worried now, but more time and more confidence on the part of smart investors is necessary before I can raise this indicator from its current neutral stance. Odd-lot selling compared to odd-lot buying is still neutral and needs to show substantially more selling by odd-lot investors to turn this indicator bullish.

Finally, let's look at the flow of funds into the Rydex family of mutual funds.

S&P 500 vs. Rydex Money Flows

Click here for larger image.

I only have about 2½ years of data from this indicator, but it has been one of the best at forecasting recent stock market moves. The indicator, shown in red, measures the flow of funds into bearish funds compared to the money flowing into bullish funds. The S&P 500 is shown in black and the green trend lines are related to the average of the indicator and its standard deviation.

Most of the time, more money is flowing into bullish funds than into bearish funds. There is about a 15% difference on average, so numbers around -15 on the chart are normal. When these investors get very bearish, though, and start investing heavily in the bearish funds -- as they did in the summer of 2006 -- the indicator goes above the zero line and forecasts higher equity prices. More recently the opposite was true, as investors in these funds shifted heavily to the bullish side last fall and continuing earlier this year.

The most recent dip into negative territory has now been reversed, but only to a neutral level. More weakness and more fear (or greed on the part of short-sellers) are needed before bullish levels can be attained.

This modest improvement in my indicators leads me to reduce my target cash position from 35% to 30%. The actual cash position in my IRA at the end of last week was 40.2%.

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At the time of publication, Moore was long Complete Production Services, CGI Group, Helmerich & Payne, Integral Systems, Life Sciences Research, Stepan, LS Starrett, Stone Energy, Sauer-Danfoss, Synnex, SPDR Trust, Sybase and U.S. Physical Therapy, 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.