Getting There

Bottom Line: Traders are pulling money out of the Rydex Electronics fund at a pace unmatched in prior declines.

On February 25^th, I showed a chart of the NAV-adjusted assets in the Rydex Electronics fund. Recall that this fund invests mainly in semiconductor-related stocks and usually the assets in the mutual fund track movements in the SMH very closely. At the time, I showed that assets in the fund (on an adjusted basis) were as low as they had been at any time since last March, and IF the uptrend was still intact, then we were seeing the type of pessimism that lead to short-term rallies over the past year. Previously, the SMH was able to rally nearly 7% within a few days after such readings, so I noted that the index was at an important juncture – either it was going to rally as it had before, or it would drop below 39 confirming a downtrend. While it bounced a bit more, it did indeed confirm the downtrend by slicing through that 39 level.

Today, however, we saw something interesting in that even though SMH rallied nearly 2%, assets in the Electronics fund actually decreased from the day before. This type of activity is very rare. In fact, the last time SMH rallied at least 1.5% and assets in the fund decreased was a few months ago - 12/29/03 – which kicked off a quick spurt higher in semi stocks. The NAV-adjusted ratio I showed previously is now the lowest it has been since the Fall of 2002 and February 2003.

Something else interesting is that Rydex traders are showing more pessimism on this decline than during any other similarly-sized decline over the past few years. The table below shows other declines similar in magnitude to what we’ve seen on this last push lower along with the decline in assets in the Rydex Electronics fund during the decline.

From	To	% Decline in SMH	% Decline in Rydex Assets
06/21/00	07/05/00	15%	29%
08/23/00	09/18/00	19%	27%
08/02/01	09/04/01	17%	37%
03/08/02	04/26/02	18%	55%
11/27/02	12/17/02	16%	45%
01/12/04	03/24/04	17%	65%

On January 12^th, there was $121 million in the Electronics fund, compared to only $42 million as of Wednesday, a decline of 65% in the asset base. This is compared to a 17% drop in SMH. Other similarly-sized declines in SMH over the past few years have lead to an average drop in assets of around 43% in the Electronics fund, so on this latest drop investors have been considerably more willing to reduce their exposure to the group. This is perhaps even more surprising given that we have just seen the best performance in semi stocks in years, showing that there is a firm opinion that the top is in and there is further to go on this decline. That certainly may be the case, but I never like to side with this kind of pessimism from this particular group of traders. As far as I’m concerned, the trend in SMH is currently down, so I would prefer to see more confirmation of strength before getting too up on the group. A rally (and hold) back above 39 would help, and if that happens there should be more to go, as traders cycle back to a positive opinion on the group. Many of our Rydex indicators are currently in very oversold territory, suggesting that there is room for significant upside should the signs of a low begin to take hold.

My apologies for the brief comments, but I had an unexpected appointment this evening. We’re seeing a few signs of the “give-up” that we need to see in forming a low of any magnitude, but not enough yet that I would be willing to buy into a down-trending market. Some of the recently-released sentiment surveys are finally showing a few cracks in bullish opinion, and a few are even beginning to approach “too bearish” levels, but there is still a preponderance of bulls. As I showed in the last comment, even though some put/call ratios are giving deeply oversold readings, very small options traders are still showing absolutely no rush to protect themselves from further declines, which is never a positive sign. The market has seen excessive selling pressure (note our daily cumulative TICK indicators and the recent TRIN discussions), but that may not necessarily be a good thing if there is still too much bullishness. I continue to prefer holding back on establishing longer-term positions until there is either a clear recovery under way (a push back above last week’s lows would be an excellent first step), or more evidence of excessive pessimism. I don’t think we’re there yet.

This disclosure is not intended as trading advice in any form. It is meant as a note to subscribers that the author may have a position directly affected by the market outlook reflected in the commentary. Although the author takes great pains to remain objective in any commentaries, it is only fair that readers should know that the author may have taken positions in accordance with his market outlook. Positions can and do change at any time, without notice to the reader.