Short-term Outlook (1-5 Days):  Neutral  From Apr 23, 1215 SPX

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Equity Indicators - Updates and Extremes

From Worst To Best

Earlier this month, we went over what usually happens when the S&P hits a new high, then suffers its worst decline in two months.  The results were bullish, at least in the sense that the index typically rebounded to yet another new high within weeks.

We got another "worst loss in two months" this week, and even when we see two in relatively close proximity, it hasn't had bearish implications.

Now the bulls really have something to cheer about, at least theoretically.  We flipped from the "worst loss in two month" to the "best gain in two months", all within three days.

The "best gain in two months" was the headline that flashed through Bloomberg, though I show that yesterday's gain was slightly eclipsed by March 5th.  Anyway, let's just go with it and call yesterday the best gain in two months.

This kind of worst-to-best-in-two-months move actually wasn't all that rare going back to 1928, but a big reason for that is highly volatile conditions during bear markets.  So let's restrict our look-back to only bull markets (simply defined as a rising 200-day moving average) and see how the S&P fared going forward:

Pretty bullish, overall.  The very short-term returns (not shown) were a little bit weaker than average, but still not what I would consider outright bearish.  By a week later, the momentum really took hold.

Excepting the October 1929 outlier, none of them showed a major decline during the following month or so, though by three months later a couple of them had started to crack.

There were only three that occurred when the S&P had been at a high right before the big decline (they have an asterisk next to the date in the table above).  One of them led to a rocket-ride higher with barely any pause, while the other two were much more mixed over the next 1-3 months.

Mutual Fund Cash %

The Investment Company Institute just released its latest monthly report on the mutual fund industry.  One of the more interesting figures is the level of liquid assets (i.e. cash) held by funds expressed as a percentage of their total assets.

It just sank to a new all-time low.

This is typically viewed as a measure of sentiment - high levels of cash mean fear, low levels mean complacency.  I've written repeatedly over the years that it's not quite that simple.  Ever since the late 1990's, fund managers have gotten into trouble by raising cash when they thought the market was due for a fall (even if they were correct in that assessment and saved their investors money).

There are other reasons why cash levels could be low, having little to do with sentiment.  Such as interest rates.  When short-term rates are very low, then there isn't as much incentive to hold cash as there is when rates are at, say, 10%.  This is the reasoning behind the Mutual Fund Surplus/Discount chart we post to the site.

This figure stood at a premium of over 1% in early 2009, meaning that fund managers were theoretically holding 1% more cash than they "should" be, a sign of fear.

Now it has swung back to a discount of -1.2%, which is the largest discount since February 2008.  Still, historically the market hasn't run into real trouble until the discount dropped to -2% or more.  Given how low interest rates are right now, fund managers would have to drop their cash levels to 2% of total assets to get the discount to -2%.

Either that, or the rates on short-term TBills would have to rise to 1.75% or more.  That seems quite unlikely given recent statements by the FOMC, assuming they have the ability to jawbone the market enough to keep short-term rates as near 0% as possible for as long as possible.

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