Richard Moore, CFA, writes about strategies for asset allocation in IRAs.
Stock-market volatility certainly continued last week on both the upside and downside. The media further brought out the recognition and acceptance that we have some serious economic problems as the economy was discussed on the Sunday news programs.
Interestingly, the market totally flip-flopped its leadership, with the financials extremely strong and commodities turning much weaker.
My indicators continued to improve last week. A couple of them are at extreme levels not seen in at least five years. The equity put/call ratio is one of those indicators and is calling for at least an intermediate-term bottom in stock prices. Similarly, the difference between the confidence levels of smart investors compared with dumb investors is also at an extreme bullish level.
Also remaining bullish, although not at an extreme, is the volume of short selling by odd lot investors compared to their purchases. These smaller investors remain concerned about stock market prospects.
I also look at the volume of selling plus short selling by odd lot investors and compare that to total odd lot purchases and that indicator remains neutral. The other neutral indicator that has continued to improve and could easily turn bullish soon is the money flows into bearish Rydex funds compared to the flows into bullish funds.
Let's look now at the ratio of Nasdaq volume to NYSE volume:
This chart is a weekly plot of the Nasdaq volume divided by NYSE volume in red. The S&P 500 is shown in black and the green trend-lines relate to the indicator's average and standard deviation. Last fall we saw a huge increase in speculation as measured by this indicator and it has taken several months to reverse this trend. Last week, though, the ratio declined measurably to levels that are usually associated with stock market bottoms.
I had to remind myself last week that my approach is not really driven by market timing as such. Instead, I attempt to reduce market exposure in response to market conditions that exhibit above average risk. Those conditions were in place late last year and during the first part of 2008. However, none of my indicators is bearish now and I believe I should move to a fully invested position.
Does this mean that the market bottom has been seen? I honestly don't know, but I believe the decline we have seen goes a long way toward discounting the expected economic weakness. Therefore, I have reduced my target cash position from 20% to 6%. The actual cash position of my IRA at the end of last week was 21.4%.
My biggest problem now continues to be identifying stocks to buy. The preponderance of stocks currently identified by my screening system as potential purchases are in the energy industry. I have been reluctant to increase my exposure to that economic sector, both for diversification reasons and because I felt that the commodity-oriented companies would likely be the most vulnerable in the final stages of this decline.
Last week that scenario seemed to play out as commodities were very weak and financials recovered strongly. In fact, the limited number of commodity-related companies held in my portfolio caused me to suffer a decline in value even as the major averages were up.
Looking at future leadership, though, it would be highly unusual for financials to assume a market leadership position. It will probably take an extended period of time for investors to begin to focus on the long-term positives as opposed to the ongoing problems.
I am continuing to use
S&P Depository Receipts
in order to keep my cash position near targeted levels (I again added to my position last week) and I fully expect that new ideas will begin to present themselves as the stock market bottoming process continues. Hopefully, I will soon begin to see stocks appear on my one-month screen so I can begin to use those ideas as well.
My biggest winner last week was
which was up 11.3%. In spite of that increase, I continue to like this company and feel that it has good future potential. It sells at a 20% discount to the scientific and technical industry when measured by enterprise value/EBITDA and earnings prospects are very good.
The table that follows shows all of the current holdings in my IRA as of the end of last week:
Richard Moore has 40 years of experience in various facets of the investment business. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Moore appreciates your feedback;
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