Market Short-Term Oversold, But...
(July 1, 2010)
Dear Subscribers and Readers,
Make no mistake – the U.S. stock market broke important technical levels at the close yesterday and looks horrible on a technical basis. The only counter-argument one could make is the fact that managers are dumping equities because of end-of-quarter “window dressing,” or redemptions. The latter makes sense, as the equity mutual fund cash levels is still hovering near a record low as of month-end May 2010 despite a slight uptick in May, as shown in the following chart:
Despite the slight uptick in May, mutual fund cash levels stood at only 3.6% at the end of May – close to its record close level of 3.5% during the February to April 2010 timeframe (and month-end July 2007, just two months prior to the ultimate peak of the October 2002 to October 2007 bull market and right at the peak of the NYSE Common Stock Only Advance/Decline line). As a result, I'm not surprised if redemptions are causing managers to dump stocks, especially given the end-of-the-quarter “window dressing” period.
That being said, there is no doubt that the breach of important technical support levels is very ominous in the intermediate term (in the short term, the market looks ripe for a bounce). Combined with the European sovereign debt crisis overhang, we would not be looking to go 100% long in our DJIA Timing System, just yet (the closest support level is 1,000 on the S&P 500). In addition, our liquidity indicators aren't looking very bullish either, as exemplified by the amount of "investable cash on the sidelines" versus the S&P 500 market cap – which has come down dramatically since the February 2009 peak, as shown in the following chart:
As can be seen in the above chart, the ratio of investable cash (retail money market funds + institutional money market funds + total checkable deposits outstanding) to the S&P 500 market capitalization has been making new rally lows consistently since the beginning of this bull market. This somewhat changed with the stock market correction in May to June – with the ratio rising by 4.40%. However, this ratio has come down too far, too fast, and remains low relative to its readings over the last two years despite the recent uptick. Probability suggests that the market hasn't made a sustainable bottom yet, unless: 1) A major central bank announces a new liquidity facility (e.g. the Federal Reserve announces an extension of its “credit easing” program or if the European Central Bank monetizes Greek sovereign debt), or 2) a major technology (one that could speed up global productivity growth) is commercialized over the next several months (which is not likely).
Conclusion: We continue to look for an opportunity to shift from a 50% to a 100% long position in our DJIA Timing System. While the U.S. stock market is due for a bounce, the intermediate term technical and liquidity indicators are not supportive of any sustainable rally over the next few months. Combined with the European sovereign debt crisis overhang, subscribers should remain cautious and opportunistic. Don't catch a falling knife, just yet.
Henry To, CFA