Richard Moore, CFA, writes about strategies for asset allocation in IRAs.
The market is still trying to find its footing and the news from General Electric (GE) on Friday reminded investors that earnings news over the next couple of quarters will probably not be fun reading.
While it doesn't seem to me as though we are likely to make substantial new lows, my indicators have weakened a bit, and a trading range might be the most likely scenario for a while.
My indicators didn't really change much last week with one major exception. The problem, as I discussed last week, is in the ratio of Nasdaq volume to volume on the NYSE. This ratio is meant to show the level of speculative activity in the market and therefore the amount of risk being assumed by investors at any given point. Ratios over 1.4 are worrisome, while ratios under 1.2 are attractive.Last week the ratio increased again to a high 1.54. I'm frankly amazed that investors are willing to speculate, given the market action of the past several months, but it seems that the gambling spirit is still alive and well. I am downgrading this indicator to an extreme bearish position until it declines into at least neutral territory. Most other indicators remain just fine. The ratio of odd lot sales to odd lot purchases continues to be neutral, as does the money flow into bullish Rydex Funds compared to flows into bearish funds. I am continuing to rate as bullish a comparison of odd lot short sales to odd lot purchases. The confidence level of smart investors compared with dumb investors deteriorated last week, but the 10-week average remains at an extremely bullish level. Finally, let's look at a chart of the equity-only put/call ratio on the CBOE:
|Click here for larger image.|
I've redone this chart again to adjust for what I see as an increasing trend in the indicator over time. Clearly the use of put options has become a more widely used risk-reduction tool and, as a result, the ratio has a tendency to increase slowly over a period of years. Therefore, this chart has been detrended by comparing the current 10-week moving average of the ratio to a best-fit data trendline over the last 15 years. That line is shown in red, while the S&P 500 is shown in black. The green trend lines relate to the long-term average of this indicator and its standard deviation. As the market has declined, this indicator has steadily increased and last week the 10-week moving average crossed into very bullish territory, matching extremes that have rarely been seen in the last 15 years. Because of the problems mentioned earlier with the Nasdaq/NYSE volume ratio, I am increasing my cash target from 6% to 21%. At the end of last week, the actual cash position in my IRA was 18.3%. I sold my position in Kinetic Concepts (KCI) last week because I had held the stock for 14 months and it no longer appeared on my screening system as a buy. My holding period for purchases is typically seven months, but Kinetic Concepts continued on my screening system at the end of seven months and I continued to hold for an additional seven months. I also eliminated my position in ICF Industries (ICFI) because the stock has suffered a 20% decline in price since purchase. I use that price decline threshold to re-evaluate any holding and I will usually sell unless there is some special reason to continue to hold.