IRA Investing: The Volatility Continues

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

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) 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%.