IRA Investing: Clinging to a Small Gain

I've got to admit, this is one of the strangest market environments I have ever seen.

Certainly the economic news remains downbeat. The fact that the market is questioning the survival of Fannie Mae (FNM - commentary - Cramer's Take) and Freddie Mac (FRE - commentary - Cramer's Take) has to be considered a huge negative, and the failure of IndyMac just puts an exclamation point on the financial stock free fall.

But then I look at most of the energy stocks and various other commodity-oriented equities, and they continue to hold up and, in some cases, move higher. My own portfolio owns enough strong stocks so that I have been able to make a tiny profit so far this year. I would like to hold on to that advantage.

There is no disputing that we are in a bear market now, but the real question is how we can invest going forward to make the best of a very uncertain outlook. Unfortunately, although my indicators are improving somewhat, they are still not showing that the level of panic among smaller and less-sophisticated investors has reached a level associated with major stock market bottoms.

Checking Sentiment

All of my indicators are actually in neutral territory. The level of confidence among smart investors compared with dumb investors has widened nicely and will probably turn bullish soon but is still neutral. Fund flows into the Rydex family of funds are also shifting to the bearish funds but not yet enough to move this indicator from its current neutral reading. The equity put/call ratio has also improved but is not near levels seen in mid-March and is still neutral.

I have moved away from using the ratio of Nasdaq volume to NYSE volume as an indicator, because too much volume has moved away from the floor of the NYSE to other markets, including the Nasdaq. This is causing large distortions in the volume ratio, and I no longer trust the indicator.

Instead, I am going to use a third indicator that focuses on the behavior of small, odd-lot investors. Two of these three indicators, the ratio of odd-lot short sales to odd-lot purchases and the ratio of total odd-lot sales (including short sales) to odd-lot purchases have been neutral and continue in neutral territory.

Let's look at the third indicator, the ratio of simple odd-lot sales to odd-lot purchases:

Click here for larger image.

This is a five-year chart showing a 10-week moving average of the ratio of odd-lot sales to odd-lot purchases in red. The S&P 500 is shown in black, and the green trend lines relate to the average of the indicator and its standard deviation. This indicator has been adjusted to remove longer-term trend influences. When these smaller investors are buying heavily, the on-balance ratio declines to low levels and gives a bearish reading. This is what has been happening most of this year until last week, when odd-lot selling picked up a bit, pushing the indicator from bearish to neutral.

My biggest market concern relates to leadership and my ability to find new stock ideas to buy. I believe it is highly unlikely that a new bull market will begin with the same energy and commodity leadership, and there is no clear indication of any other groups moving into position to lead a new bull move. It seems more likely that the market will continue to be volatile and that groups that have been strong will ultimately catch up on the downside.

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At the time of publication, Moore was long Conmed, Complete Production Services, CGI Group, Helmerich & Payne, Integral Systems, Life Sciences Research, Open Text, 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.