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Still Sitting and Waiting

(September 2, 2010)

Dear Subscribers and Readers,

Ideally, two lovers come together not just through mutual inspiration; but also to embark on a life and spiritual journey together—one that only the two unique individuals could make.  It is more than a Karmic connection.  It is a spiritual connection.  To this end, shows like Bachelor and Bachelorette make a mockery of this ultimate union, and ultimately, is a manifestation of modern society's views on marriage and relationships.  Interestingly, the first such “competition” could be found in Greek mythology, when Paris (a demigod) was commissioned to decide once and for all who was the most desirable goddess on Mount Olympus—Athena, Hera, or Aphrodite.  Athena offered Paris valor; Hera honor and position; and as our subscribers know, Aphrodite offered Helen of Troy.  Paris picked Aphrodite.  The losers, in a fit of jealousy, helped plotted the destruction of Troy.  Ten years after the technology bubble burst, signs of material excesses still abound, with no room for self-introspection, despite the latest recession.  Would it take another devastating bear market (i.e. the analogy is the destruction of Troy) before more Americans introspect and find their true purpose in life?  At the peak in 2000, the P/E ratio of the S&P 500 hit 40; do all extremes ultimately become their opposites?  Make no mistake: I believe we're still in the cyclical bull market that began in early March 2009.  My “base case” scenario is for the Dow Industrials to trade in the 9,000 to 15,000 range for the next few years; with a structural bull market (based on Schumpeterian growth that would ultimately emerge from new biotech, green tech, and nanotech technologies) to begin sometime in the 2013 to 2015 timeframe.  But given the history of the market to swing from one pendulum to another – and given the unfunded retirement and medical obligations around the world – I would not be surprised if another devastating bear market emerges sometime in the next couple of years.  Stranger things have happened.

Enough about Greek mythology and the implications of today's material excesses—let's focus on the immediate question at hand.  Carl Swenlin at (subscription only) commented that Tuesday and Wednesday's action completed a bullish “island reversal”—which also resulted in an upside breakout from a downward channel (on the daily chart) since the early August peak.  However, Carl Swenlin note that its intermediate-term trend indicators were still bearish, and thus some more sustainable upside is needed for his technical indicators to turn bullish.  We agree.  While today's (Lowry's) 90% upside day was impressive from both an upside breadth and volume standpoint, one cannot yet conclude that the market is on a sustainable upside path just yet.  In fact, long periods of consolidation are not rare in bull markets.  The indecisiveness in the market action from February 2004 to October 2004 is one such example.

At any rate, our liquidity indicators are still relatively weak—and thus not supportive of a sustainable rally just yet (especially given the uncertainty leading into the September 21st FOMC meeting).  For example, the amount of “investable cash on the sidelines” versus the S&P 500's market cap – has come down dramatically since the February 2009 peak, as shown in the following chart:

Note that we have updated the numbers to account for yesterday's huge rally.  As referenced 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 consistently hit new lows since February 2009.  This somewhat changed since the end of April – with the ratio rising by 2.86% during that time (from 32.29% to 35.15%).  However, this ratio has come down too far, too fast, and is still low relative to its readings over the last two years.  This liquidity is thus suggestive of a more consolidation going into the next FOMC meeting (whether the market will subsequently rally will depend on the Fed's actions on September 21st). 

Another liquidity indicator - equity mutual fund cash levels – is actually flashing very bearish signals.  In particular, cash as a percentage of equity mutual funds' assets declined from 3.8% as of the end of June to a record low of 3.4% as of the end of July, as shown in the following chart:

Note that the record low of 3.4% is even lower than the previous record low of 3.5% set in July 2007—near the peak of the last bull market.  Given the lack of cash flows into equity mutual funds in August, and given the ongoing lack of interest in equities, the buying power of equity mutual funds will likely remain anemic for the foreseeable future.  We will continue to take a wait-and-see approach.  Should the stock market decline substantially into the September 21st FOMC meeting, we may shift to a 100% long position, until most likely, we will wait for the results of the FOMC meeting before making a move.

Signing off,

Henry To, CFA

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