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IRA Investing: The Volatility Continues

Richard Moore

Just looking at the end result of last week, we might be tempted to categorize the market action as uneventful.

However, as we know, it was anything but.

The largest market gain in five years on Tuesday was followed by additional weakness leading to the Bear Stearns(BSC Quote - Cramer on BSC - Stock Picks) collapse.

This is certainly the type of activity that is seen around market bottoms, but my indicators were mixed last week, leading me to maintain my previous outlook and strategy.

I have previously discussed the two indicators that are giving extremely bullish readings. The equity put/call ratio on the CBOE increased even further last week and is now at the highest reading in the last five years.

Friday's ratio was an outlier on the high side. The confidence level of smart investors is moderately high and increasing while the confidence level of dumb investors continues to decline, indicating that these less sophisticated market participants are expecting some form of dire economic collapse. The difference in confidence levels is at a very bullish extreme.

On the bearish side, we still have a level of Nasdaq volume that is too high when compared with NYSE volume. This indicator is improving but needs to decline to a level around 1.3 for a few weeks to upgrade the indicator to neutral.

The level of odd-lot sales compared with odd-lot purchases declined last week as smaller investors bought into the big rally on Tuesday. Although the indicator remains neutral, we need to see more skepticism among these investors when the market rallies to turn this indicator positive.

Money flows into bearish Rydex Funds compared to the flows into bullish funds continues to improve but is still neutral.

Another indicator that shows the brief swing to optimism by small investors last week is the ratio of odd lot short sales to odd lot purchases. Let's look at a chart of that indicator now:

Click here for larger image.

This ratio, shown in red is the 10-week moving average of the de-trended ratio. To get a de-trended value, I am dividing the 10-week moving average by a long-term average of the indicator.

The S&P 500 is shown in black and the green trend lines relate to the indicator's standard deviation. We can see that, prior to last week, this indicator was bullish and moving toward an extremely bullish position.

Last week, though, the indicator reversed itself as odd lot shorting decreased and purchases increased while the market jumped up on Tuesday. Even with the pullback, the indicator remains in a bullish posture.

Taking all factors into consideration there was no change in my longer-term characterization of the market as neutral. I believe more time and/or market weakness will be needed to turn this market around. My target cash position also remains unchanged at 20%. The actual cash position of my IRA at the end of last week was 25.6%.

Last week, I eliminated two positions from my IRA based on a loose stop-loss provision I use to eliminate mistakes before they can become major disasters. When I hold a stock that declines in value by 20% or more and stays at that level for a few days I will usually admit my mistake and look for better alternatives. So, last week I sold my positions in Commscope(CTV Quote - Cramer on CTV - Stock Picks) and Frontier Oil (FTO Quote - Cramer on FTO - Stock Picks) on that basis.

I reinvested the proceeds and also some additional cash into S&P Depository Receipts (SPY Quote - Cramer on SPY - Stock Picks). I am continuing to find it difficult to come up with new ideas for investment in this market environment. So I am using this ETF as a proxy for the market until more interesting ideas show up on my screening system.

I also took a new position in Life Sciences Research (LSR Quote - Cramer on LSR - Stock Picks). This is a contract research organization that supports companies in the biotech, drug and agricultural chemical industries. The company attempts to identify risks to the environment or users of various products.

Growth has been excellent over the last few years, as the company has posted an average annual growth in sales of about 15%. Last year revenues increased by 23% and adjusted operating income was up 58%.

The future growth rate of the research services industry is widely expected to be well above average. Therefore, the median enterprise value/EBITDA ratio for this industry is currently 16.5.

Life Sciences sells at more than a 30% discount to this figure at about 11.4 times. While this is a smaller company with fairly thin trading volume, I believe the current discount is excessive. The company is also less subject to economic fluctuations.

The table below shows all the current holdings of my IRA as of the end of last week: