A Note of Caution, But It Still Looks Good
Thursday, October 28th, 2004 7:50pm EST
No Mo’ Money
Bottom Line: Once again, we focus on Rydex traders, but this time we see that they have abandoned the safe money market for other funds. That has been a consistent yellow flag in the past.
In the last comment, I wrote about Rydex traders and their usefulness as a contrary indicator at the extremes. Last time it was regarding banking shares, the time before that it was transportation stocks, now there is another development which I feel merits a look.
One of the indicators that is posted to the site looks at assets in the money market fund at Rydex as a percentage of the total assets in all the major index funds. By looking at this percentage, we can get a feel for how confident traders are in their positions, either bullish or bearish. If they are uncertain about market direction, most likely they will transfer assets from one of the index funds into the money market until they see things clear up; if they are confident about market direction, however, then there is no sense in them keeping their money locked up earning only a bit of interest – instead, they will transfer money to one of the index funds.
The chart below shows a five-year view of money market assets as a percentage of total index assets.
In 2000, the money market only attracted about 20% of the assets. Most of the money that was not in the money market was in the long-side funds that Rydex offers, and we all know how that turned out. With the decline into the Spring of 2001, assets in the money market shot up to around 45% of total assets, a level that was exceeded after 9/11 and again in July 2002, when over half of the assets was “safe” in the money market.
Since that display of extreme uncertainty, traders have been putting less and less money in the money market relative to their allocations elsewhere. Since early this year, assets have oscillated between about 27% and 31%, a range that hadn’t been seen since May 2001. But let’s take a closer look at the activity for just this year, as it has been a consistent guide to the sentiment of Rydex traders. Red circles highlight the other times the money market fund has been shunned to as great a degree as it was yesterday.
While not perfect, generally what we see is that the higher the level of assets in the money market, the greater the uncertainty, and the better the short-term performance of the S&P 500 going forward. On the other hand, when assets dropped below 28% of the total, the broader market had a very difficult time making headway this year. There have been a total of 12 days this year when the money market made up less than 28% of total assets, and 9 of those times the S&P was lower one month later, with an average return of -1.9%. This is somewhat misleading since most occurrences took place in the year 2000, but if we look back over the past five years, the 90-day return in the S&P after such instances is -8.4%, with a whopping 138 out of 140 days showing a negative return. Looking at the 90-day returns just since March 2003, we still see that only 1 out of 13 occurrences was positive, though the average return was “only” a loss of -2.8%.
There is nothing inherent about this data that means the market has to go down, as the absolute dollar value of money in the Rydex money market fund is so small as to not be meaningful. The value comes in its potential as a reflection of the sentiment of traders who are normally wrong on market direction at the extremes. We are still not seeing huge spikes higher in the Beta Chase or Enthusiasm Indexes, so there is not a lot of evidence just yet that these traders are throwing caution to the wind. Still, the consistency of the percentage of assets in the money market and its relation to future stock market performance is considerable, and at the very least it should be noted, because if we begin to see more evidence of outright speculation in the coming days, it may be time to tone down bullish expectations.
Conclusion
On June 17th, I noted the potential problem of declining call open interest in OEX options. This is a very rare occurrence, and when it comes in bunches it can highlight trouble with the market. The stat I gave then was that any time the number of open call contracts in OEX options fell twice within 10 days (excluding option expiration when it will fall by definition), the S&P was lower 90 days later 72% of the time and showed an average return of -4.3%. I bring this up now because today call open interest declined for the first time since June, and to the greatest extent since early February. I don’t think one day of these traders closing out their call positions is all that worrisome, but should we see another occurrence in the next week or so, it would pique my interest much more.
Something that I have seen mentioned regularly is the very positive seasonality entering November. That does tend to be the case, as the first three days of November have been up about 65% of the time since 1950. Looking only at those times when the last three days of October have been up 2% or more entering November, the first three days of the new month were up 4 out of 8 times and the average return stayed at just under 1%. So, it was still rare to see much weakness entering the month even when October ended strongly (of course, we have the election this time around, so FWIW).
In the last comment I noted several examples of conflicting signals from several of our measures. Now we can add odd lot volume to that list - yesterday odd lot purchases were the highest in four months, yet odd lot short sales were also extremely high. The 5-day average of odd lot short sales, which is what is posted to the site, is now over 1.25 million shares. 30 days after this has occurred in the past, the S&P was higher 29 out of 34 days for an average gain of 3%. As I said then, when we see these types of conflicts from so many measures, I look for a trading range environment, and I don’t see much to change that now. My continued preference is to concentrate on the long side, at least for now, but should we get more of the readings like we’ve seen in the past couple of days, the risk/reward will shift increasingly away from longs.
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.