This indicator implies prices will go higher
After the decline that lasted from the beginning of May to
mid-June, a second bottom was made in July, from which the current rally
emerged. Both the bottoming process and the rally have been rough and tedious,
causing a lot of anxiety among market participants, and resulting in strong,
persistent bearish sentiment. This is clearly visible on our first chart of
Rydex Cash Flow analysis.
The first panel below the S&P 500 chart shows cumulative cash flow (CCFL) for
bull plus sector funds. Note how the indicator has been running flat for the
duration of the July/August rally, a reflection of caution. On the other hand,
the next panel down shows that CCFL for bear funds has been increasing for most
of that period and shows that the bears are nearly as committed now as they were
at the June price low.
Our next chart is of the Rydex Cash Flow Ratio*, which summarizes the elements
of the first chart into a single indicator. Again, we see that the Ratio has
stayed near the bearish extremes of the three-year range, even as prices
approach new highs. This brings to mind the psychological term “cognitive
dissonance”, which is the pain we experience when our belief is in conflict with
reality. Surely the bears must be feeling some pain.
Bottom Line: If the rally had been stronger and smoother, it would
probably been sufficient to shake out the bears and attract the bulls, shifting
sentiment to the bullish side of the range. As it is, I think we must assume
that prices will move higher until sentiment turns more bullish. Such an
adjustment could occur within a few weeks.
Technical analysis is a windsock, not a crystal ball. Be prepared to adjust your
tactics if conditions change.
*RYDEX CASH FLOW RATIO: The Rydex Cash Flow Ratio gives an improved view of
sentiment extremes by using cumulative cash flow (CCFL) into Rydex mutual funds
rather than using the totals of assets in those funds (which we use for the
Rydex Asset Ratio). It is calculated by dividing Money Market plus Bear Funds
CCFL by Bull Funds plus Sector Funds CCFL.
Carl Swenlin is a self-taught technical analyst, who has been
involved in market analysis since 1981. A pioneer in the creation of online
technical resources, he is president and founder of
DecisionPoint.com, a premier
technical analysis website specializing in stock market indicators, charting,
and focused research reports. Mr. Swenlin is a member of the
Market Technicians Association.