Looking for One More Push
Tuesday, August 10th, 2004 9:10pm EST
Rydex traders finally give up
Bottom Line: Asset flows among various Rydex funds over the past two days highlights a change in attitude among traders that has been long absent. This type of “give up” is a good sign for the longer-term health of the market.
In an intraday note early this morning, I noted the dramatic shift in investor psychology we were seeing from those who trade the Rydex funds. Despite the broader market enjoying a generally positive day on Monday, Rydex traders moved $38 million out of the bullish-oriented index funds and a net $92 million into the bearish-oriented funds. This shift of $130 million on an “up” day in the market was the largest such asset move we had seen since August 6th, 2003. That day just happened to be one where the S&P broke below its previous support, apparently leading these traders to believe the market was headed lower. In true contrary fashion, it was also the exact low as we went on to enjoy an excellent Fall rally.
We can see this negativity in two of our more responsive Rydex indicators. The Enthusiasm Index, which monitors asset flows in comparison to market performance, is at its lowest point since last September. A low reading in this indicator means that Rydex traders have shifted more money out of the bullish funds or into the bearish funds than they “should” have given how the S&P 500 and Nasdaq 100 performed that day.
Our Rydex Beta Chase Index, which measures the relative preference of these traders for high-beta (a.k.a. “risky”) funds versus low-beta (a.k.a. “safe”) funds, reached its lowest reading since March 11th. We’d have to go back to February 7th of last year to see a similarly low reading. Yesterday’s Beta Chase reading of 0.28 essentially means that Rydex traders were 3.5 times more likely to invest in a safe mutual fund than a risky mutual fund. Contrast that to June 30th, when these traders favored risky funds over safe funds by a factor of 19 to 1, or even as recently as August 2nd, when risky funds were 7 times more favored than safe funds.
Much of this is due to an increase in activity in the short-side index funds that Rydex offers, particularly the leveraged funds. Tempest and Venture, the two funds that profit $2 for every $1 the S&P 500 or Nasdaq 100, respectively, declines, have gained nearly $195 million in assets since August 3rd. That is a gain of 16% in assets despite losses of between 3% - 4.5% on the underlying indexes. This has pushed the total dollar value of assets in the leveraged short funds to $1.22 billion, which is just shy of the all-time record of $1.25 billion set on February 12, 2003.
Obviously we will not know if these assets have peaked until after the fact, most likely after the market has rallied a good deal. But the point is that already, there appears to be quite a substantial short bet placed on further declines, which should and will add fuel to a rally when it begins.
Fed Reaction Precedent
Bottom Line: Last January’s reaction to a Fed meeting was eerily similar to today’s. The lesson is that it is not always wise to trust the knee-jerk movements on a Fed decision day.
I’m always suspect of carrying historical comparisons too far, but I do believe once in a while they can provide useful templates going forward. Last time we looked at how the market has reacted after previous extreme one-day put/call readings, and they were consistent with what we have seen over the past few days.
Today’s price action in the S&P 500 also compares very favorably with another historical example. Let’s look at the intraday behavior in the S&P from January 29th, 2003 (another Fed meeting day) and compare it to today’s:
We can see that in both instances, the index rallied up until the Fed decision, then dropped after the announcement. Soon afterwards, however, the buyers stepped up again and rallied us well into the close.
The reason I bring this up is because the technical circumstances are so similar, as the following daily chart shows:
At point 1 on the chart, the S&P had broken down from the support levels created in late 2002. A few days later (point 2 and green bar), the Fed had its meeting and the market received it well, as we saw above. That Fed-day rally took the S&P right back to the breakdown level seen a few days earlier. This scenario is a near carbon-copy of what we are currently seeing.
Point 3 shows the post-Fed reaction and it is not exactly encouraging. Reactions to Fed decisions are notorious for being reversed in the short-term, and we saw that in January. The market declined hard the next day, rallied a bit more, then went back into its decline. Combined with what I showed last time for the extreme put/call ratios, this fits pretty well and may give us a good template with which to work. Obviously, no two times are ever exactly alike, especially with regards to reactions to economic indicators, but as long as the precedent isn’t taken too far, it can be a reasonable guide.
Conclusion
In this morning’s intraday comment, I noted that odd lot short sales (bets against the market for 100 or fewer shares) totaled 2.59 million shares on Friday, a new 34-year record by a wide margin. As a percentage of total sales, these shorts accounted for 18%, the highest amount since three days in March and April 2001 (as the market was bottoming). We would have to go all the way back to March 1996 to see another day with as high of short sales as a percent of the total. Since 1970, any time odd lot shorts have made up at least 18% of total odd lot sales, the S&P was higher 60 days later 80% of the time, with an average return of 3.4%. One year later, it was higher 85% of the time with an average gain of just under 11%.
With the Rydex data, put/call ratios and odd lot shorting information all suggesting that wrong-way traders are betting heavily against this market, it is awfully tempting to believe that the worst is already behind us. Add to that the fact that SPY and QQQ volume has been very high compared to the volume in the underlying component stocks (check out the SPY Liquidity Premium), a good sign of trader uncertainty, and it looks like many of the previously missing pieces are beginning to fall into place.
There are still signs of excessive bullishness or complacency, as I mentioned last time. If we could see one more push down, breaking Friday’s lows, I believe those last pieces would fall into place and it would be time to become more aggressive than at any previous time this year on the long side. We’re not at that point yet, so it would take a much improved technical picture to emerge before adding to long positions would make sense.
In the short-term, a few of our intraday measures eased into overbought territory by this afternoon. Given the stiff resistance immediately above, it seems unlikely that the bounce we’ve seen the past couple of days will make it much further before more declines are seen. If the market can rally in the face of short-term overbought readings, it lends more credence to the thought that an intermediate-term low is in place, but I think it’s unlikely we’ll see that now.
Jason Goepfert
President and CEO
Sundial Capital Research, Inc.
Disclosure: no positions
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.
© 2004 Sundial Capital Research, Inc. All Rights Reserved.