IRA Investing: Indicators Continue to Improve

Richard Moore, CFA, writes about strategies for asset allocation in IRAs.

Last week investors again suffered as the market continued to discount a future that looks very problematic. The only comic relief was provided by the political campaigns as mud-slinging escalated into name-calling and reminiscing about the impeachment hearings of the 1990s.

It is beginning to look, though, as if most of the negatives are becoming priced in to the stock market. On Friday, Bill O'Reilly had a segment titled "Will The American Economy Collapse?"

And then on Saturday, The Wall Street Journal had a front-page story headed "Jobs Data Suggest U. S. Is in Recession." When economic weakness becomes so well recognized and the fear of collapse permeates the discussions on mainstream TV, most of the stock market damage has probably been done.

While all is not roses, my indicators are beginning to reflect the probability that the worst is over. I say all is not roses because some of my indicators, while improving, are still not in position to forecast a better future and those indicators will require more time and possibly more weakness before they fall into line.

Specifically, the ratio of Nasdaq volume to NYSE volume remains too high and is still rated as bearish. This ratio flashed a warning in the fall of 2007 and has remained stubbornly high ever since.

I also have a couple of indicators that remain in the neutral area. The ratio of odd lot sales to odd lot purchases remains lower than I would expect given the magnitude of this decline and remains rated as neutral. The money flows into bearish Rydex Funds compared to the flows into bullish funds continues to improve but is still rated as neutral.

Last week my indicator that measures odd lot short sales compared to odd lot purchases improved to bullish from neutral. Odd lot short selling continues at a very high level. The chart that I presented last week, put volume compared to call volume on the CBOE, increased again last week and remains extremely bullish. Finally, let's look at the stock market confidence level of smart investors compared to the confidence level of dumb investors:

Click here for larger image.

This is a five-year chart of a 10-week moving average of the difference in confidence levels between smart investors and dumb investors shown in red. The raw data is available at sentimentrader.com. The S&P 500 is shown in black and the green lines relate to the indicator's trend and standard deviation. Currently, the confidence level of smart investors is moderately high and will probably go even higher if the market declines further.

The confidence level of dumb investors is about as low as it can go, indicating that his group really feels that an economic collapse is a real possibility. The difference between the two confidence levels is very high and increasing, leading me to rate this indicator as extremely bullish now. The indicators have not yet improved enough for me to upgrade my long-term outlook. It remains neutral.

However, I now feel that a substantially lower cash position is warranted and I have reduced my target cash position from 35% to 20%. The actual cash position in my IRA at the end of last week was 33%. I will be looking for opportunities to make stock purchases this week. Last week I increased my position in S&P Depositary Receipts SPY in order to reduce my cash position to previous target levels. In this environment, it is very difficult for me to come up with new individual stocks to buy because my screening system looks for strong stocks and, I believe, it is too early for this screener to identify market leaders in the next bull move.