Is There Enough Cash on the Sidelines to Lift Stocks to New Highs?Posted on Saturday, May 28, 2011 - 08:42 am
Ask any business owner and he'll tell you how important a full pipeline is. If there are no prospects or sales in the pipeline, there won't be any new revenue. What about the stock market? Is there enough cash on the sidelines (or in the pipeline) to drive stocks to new highs or at least keep them from slumping?
Good News - Bad News
Strictly from a cash flow point of view, there is (short-term) good news and (long-term) bad news.
First the good news. Sentiment surveys by Investors Intelligence (II) and the American Association of Individual Advisors (AAII) show a significant drop in bullish advisors and investors.
Most recent data shows that the percentage of bullish AAII investors has dropped to the lowest level since August 24, 2010. II bulls are at the lowest level since October 19, 2010. Due to the contrarian nature of those polls, this suggests that the downside is limited.
Now the bad news. The investable amount of cash waiting on the sideline is limited, very limited.
The next few paragraphs will explain why this is pivotal to the market's direction going forward even though it doesn't have to be a short-term indicator. There is also one possible caveat that may switch things up.
Just how limited is the pile of sideline cash? If it was an Apple product, it would be an iPod Nano with 8 GB.
Mutual Fund Cash Levels
As investors, we often look at what the 'pros' or institutions are doing. Most of the 'pros' are invested to the max as is evidenced by mutual fund cash levels. As of March (latest available data from the Investment Company Institute), mutual fund cash levels were at an all-time low of 3.4%.
This is double worrisome. 1) Since fund managers are over-invested, there is not much cash on the sidelines. The pipeline of new money waiting to buy stocks is limited.
2) Fund managers have a pretty dismal track record when it comes to market timing. If you plot mutual fund cash levels against the S&P (chart available in the June ETF Profit Strategy Newsletter) you see that the only other times fund managers were as highly invested was in early 2000 and mid-2007.
At the March 2009 low, fund mangers reduced the cash level to 5.7%, the highest level in nearly a decade. At the same time, on March 2, 2009 to be exact, the ETF Profit Strategy Newsletter issued a special alert and recommended to buy broad based ETFs like the S&P SPDR (NYSEArca: SPY - News), Dow Diamonds (NYSEArca: DIA - News) and Nasdaq QQQs (Nasdaq: QQQ - News) along with its leveraged cousins.
Most fund managers missed the initial 3-month, 50% gain from the March lows. Yes, as a composite, the pros tend buy high and sell low. Fortunately the them, QE2 cash flow has artificially extended the life of this rally. But where will the money come from when QE2 is over? Not from mutual funds.
To come up with a measure of investable cash we've looked at margin debt and available cash of NYSE member brokerage firms. Based on data provided by the NYSE, 'investable cash' is at the lowest level since the 2000 and 2007 peak (detailed analysis of mutual fund assets and 'investable cash' is featured in the ETF Profit Strategy Newsletter).
When will this 'empty pipeline effect' catch up with stock prices?
Getting Ahead of the Crowd
Back in February, the ETF Profit Strategy Newsletter drew attention to multi-decade bearish chart formation that had nearly matured to perfection. On March 6, the newsletter drew the following conclusion: 'A major market top in the 1,369 - 1,xxx (reserved for subscribers) range would certainly create a technical picture for the history books. Time will tell whether this expectation is too close to perfection.'
As it turns out, perfection favored the chartist. The S&P climaxed at 1,370 on May 2, and crumbled thereafter. There were subtle warning signs leading up to the May 2 peak.
On April 25, the ETF Profit Strategy Newsletter alerted subscribers that the VIX (Chicago Options: ^VIX) triggered a sell signal. The same sell signal that portended the January and April 2010 declines. On April 26, the newsletter warned that the S&P had closed above its upper Bollinger Band and featured a chart that showed: 'that further short-term gains were limited on prior occasions when the S&P exceeded the upper Bollinger Band.'
A recommendation for aggressive investors to go short against 1,369 was given on the evening of May 1.
This week the S&P dropped below a 9-month trend line support. However, due to bearish sentiment and the overall technical picture the newsletter expected an up side bias this week. The up side bias remains in force as long as structural support is maintained.
The ETF Profit Strategy Newsletter provides semi-weekly technical forecast, which provide important support/resistance levels along with the support that must hold and the trigger level that will signal a continued rally, perhaps even new highs.