No Urgency For Protection

04/08/09 9:00 AM EST

Good Wednesday morning...We begin the day with what looks like a flat open this morning, after some early drama.  The S&P futures were heading into an ugly open right to the 800 level we've had our eye on for a long trade, but the announcement of yet another bailout (sigh...) has taken us up more than 13 points before regular trading begins.

In late March we looked at how traders of the Rydex family of mutual funds had suddenly re-discovered a few of the technology-related funds there.  There was a large and quick spike in assets in the Internet and then the Electronics funds, making them more popular than they'd been in years.  Kind of like the dork in high school who got contacts and a nice haircut over the summer, then got to hang with the popular crowd (not that I would know anything about that, cough cough...).

These weren't one-day wonder kind of spikes, and both funds have increased their assets since.

At the other extreme, we have funds like Biotechnology and Health Care, which both are attracting less than 5% of total sector assets, and which are at or near their lowest levels of the past six years...despite the funds themselves having rallied in March.

This interest in technology is also evident in the funds specifically geared to the Nasdaq 100.  Both the leveraged and un-leveraged funds are seeing an uptick in assets in the long-only funds and an asset exodus in the inverse funds that profit if the market falls.

That has pushed the bull ratios (long fund assets / short fund assets) close to their highest levels since 2003.

The only times since 2003 that we've seen the un-levered funds with a higher bull ratio were mid-May and mid-August of last year, which were not good times to be holding tech.

The bull ratio in the levered funds was equal or higher than current at the end of December 2004, mid-October 2008 and mid-December 2008, also not good times to be holding tech.

This surge in the bull ratios has been driven less from a big surge in bullish assets and more from a total lack of interest in the inverse funds.

We've touched on this before, with the possibility being that instead of buying inverse funds at Rydex, traders are using other forms of protection.  Anyone visiting a drug store recently can attest to the fact that there's more than one way to skin a cat, so to speak.

But when we look at the two most likely culprits, put/call ratios and inverse ETFs, that doesn't seem to be the case.  Put/call ratios are still showing excessive optimism - certainly no sign of urgent put trading there - and total inverse ETF volume has dried up to its lowest level since early January.

When we combine this data with the negative seasonality during earnings season and the bump above 60% in the Dumb Money Confidence that we looked at yesterday (even though it's back to 54% as of yesterday's close), it seems more and more likely that that multi-week or multi-month trading range we've been discussing will take root.

Bottom line - Intermediate-term

Nearing the end of the first week in March, we went over a number of indicators and studies suggesting that we were very likely within days of an inflection point.  Sentiment had reached an extreme (the setup) and the price pattern coincided almost perfectly with past lows (the trigger).

The market failed to follow through immediately on the upside, which was messy and somewhat unusual, but still basically within the confines of the risk parameters mentioned in the past studies.

After March 10th's "blast off" day, we needed to see some short-term follow-through, per the tables from Wednesday and Friday that week.  We unquestionably saw that, which basically meant that it would be unprecedented to not see generally higher prices over the next one to three months.

During the past week and a half, we started to see more troubling readings, and after the 20%+ rally we've seen, the outlook has been growing dimmer.  It has seemed more likely that we would be entering a multi-month trading range, with 850-875 the likely upper end of that.

As we tease the upper end of that range, it makes sense to expect the risk/reward to tilt more towards the "risk" and less towards the "reward" on long positions, and we're not expecting much sustained upside especially given what we discussed Tuesday and today.

Bottom line - Short-term

All this week, we've been looking at 790-800 as a potential spot for a long trade, particularly if we saw some oversold readings among our most sensitive indicators, due in fairly large part to some positive Good Friday seasonality.

As has been the case a couple of times lately, a government announcement has ruined what looked like a good trade possibility.  This morning's ostensible extension of the government bailout of yet...another...industry goosed the futures nearly 2% from their overnight lows.  A gap down into the support area we touched on should have made for a decent risk/reward trade.

As it stands, we're left wondering how the market will react to the latest announcement, with no clear extremes among our shortest-term indicators and no real edge otherwise.  We do have the consistent positive seasonality for tomorrow, but other than that I don't see much that's intriguing either way right here.

All the best,