More Long-term Positives In The Face Of Short-term Negatives

01/02/09 9:20 AM EST

Good Friday morning...we begin the New Year with either a positive or negative bias depending on what exactly you're looking at in terms of the stock indices.

We left the final minutes 2008 with an appropriate mix of volatility and confusion.  After the cash markets closed, the futures saw a bout of selling pressure that took the S&P 500 down from about 905 near the close of regular trading hours to 891 a few minutes later.

The Nasdaq 100 futures went from 1215 to under 1200.  In the pre-market this morning, both contracts gained back nearly all those losses, before fumbling a bit over the past couple of hours.  These sudden adjustments in a very illiquid tape are probably going to be in effect today as well as many traders will not be returning until Monday.

At the end of each month, one of the data points I like to reference is the latest data from the mutual fund industry.  While the data is released with a one-month delay, it's longer-term in nature so the lag isn't that big of an issue.  The latest release showed that yet again in November, investors fled equity mutual funds and moved into ultra-safe money market funds.

There are a few interesting aspects to this, and I just posted a Data Brief about it, so check that out for more information.  The bottom line is that the tumult in stocks has understandably led to extreme risk-averse behavior, and assets in money market funds are now enough to buy 42% of the entire S&P 500 index.

The latest sentiment survey from the American Association of Individual Investors also showed another push into safe investments.  Individual investor allocations to the stock market dipped to 42%, the lowest since 1991.  And these folks' investments in cash instruments moved up to 42%, the highest ever.

Never before have these investors allocated as much or more to cash as they have to stocks.  The data only goes back to December 1987, but that's still a pretty remarkable fact.

The only two other times when the two allocations came close were in February 1991 (42% to stocks, 38% to cash) and November 2002 (43% to stocks, 39% to cash).  Both were good times to be taking a long-term contrary stance against these investors.

Given the money market data we discussed in the Data Brief and the AAII data above, in addition to the number of positive indications we've discussed over the past few weeks (here and here and here), I'm still looking for generally higher prices in an intermediate-term time frame (one to three months).

As for what would have me backing off that idea, a move under 850ish on the S&P 500 would be the first sign to take a step back, and a break of 820ish would probably see me completely abandon it.  Also, a continued deterioration in things like the Intermediate-term Indicator Score and the Smart Money / Dumb Money Confidence would have me looking to sell into strength towards the 1000 level or so.

On a (much) shorter-term basis, the Signposts are all negative today, but the edges aren't particularly strong.  The weighted average probability of a declining market in the short-term is 47% (the same as Wednesday), which is below a random probability but is not an especially good edge.  That is particularly true when we're dealing with what has been a very illiquid market subject to choppy trading and violent whipsaws.

On top of that, we have the unknown of beginning-of-year adjustments, which could move us significantly higher or lower.  The first multi-day move of the year isn't always a good predictor of the rest of the month, as we often see a sprint one way or the other in the first few days that gets at least partially reversed in the days (and weeks) following.

The STEM.MR Model moved to an historically extreme level of 10% by Wednesday's close.  The only times in the past few years it has become this extreme were 05/26/06, 12/26/07 and 03/24/08, none of which were particularly good times to be expecting sustained short-term gains, as the market backed off over the ensuing one to five sessions each time.  We also have the added negative of the longer-term version STEM Model well into "excessive optimism" territory as well.

Bottom line, the market looks OK with the longer-term positive's we've discussed.  In a more short-term sense, I'm unsure what the beginning-of-year adjustments are going to look like, but I'm not all that optimistic that we're going to be able to sustain gains given the Signpost studies and the extreme overbought condition of the shorter-term indicators.

All the best,