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Archive for September, 2010

When mutual fund managers are very positive on the market, historically they have kept lower levels of cash on hand in their portfolios. Watching these levels has been a very good predictor of where the stock market might be heading. Consider these statistics that date back to 1961.

Throughout the 60’s, mutual funds held on average 5 to 6% of their portfolios in cash. In some instances, it was as high as 9% to 10%. Cash levels of 4% or lower was a precursor to a market decline. In other words, when mutual fund managers held around 4% of cash, it was a signal that the stock market was about to go into a bear market or at least go through some type of a decline.

The following is from a newsletter I wrote to my clients back in 2007 right before the start of the greatest bear market since the Great Depression.

In 1971, these cash levels went as low as 4% and a -9% decline followed.
In 1972, these cash levels went as low as 3.9% and a -42% decline followed.

Then the cash levels went back up to the average of 8 to 10% again for a very long time until April 98. At that point they went back under 5% for the first time in 21 years. Following that dip down to 4.8% of cash, the market dropped -19%.

Then between 1998 and March 2000, the cash levels stayed in the mid to upper 4% ranges. March 2000, saw the first dip down to 4% cash level in almost 30 years. Of course, that occurred at the top of the great bull market run that led to a -47% decline in the stock market.

In September 2005, we set another record low in cash levels of 3.8%. That led to a mild decline of -5.2%.

In March 2007, we are now at a new record of 3.7%. Does that mean we have a bear market in our future? History would suggest that we have some type of stock market trouble in our near future. The irony is that we are at an all-time in the Dow just like we were in March of 2000.

Fast Forward to Today

So, wonder where we are today? We are currently at a record low level of cash in mutual funds at 3.6%.

NEW BULL MARKETS DON’T START UNTIL CASH LEVELS IN MUTUAL FUNDS ARE CLOSER TO 10%.

That is not an opinion. That is what history has shown. With that said, I would be careful with the risk that you are taking. Things can change very quickly.

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So do you think that we are still in a recession? According to the agency that dates the starting and ending of recessions, it has been over for a long time. The National Bureau of Economic Research stated today that the recession that began in December 2007 actually ended June 2009. It has been referred to as the Great Recession because it is the longest recession (18 months) since the Great Depression (43 months).

So great! The NBER states we are out of the woods. Let me ask you a question – Is the recession over in your world? Do you feel better off than you did over a year ago? Keep this in mind when it comes to economic numbers – numbers can be manipulated and interpreted in many different ways. It is very easy to misrepresent with numbers – just remember what the government does with the unemployment report each month as a case in point.

Statistically you could say we are not in a recession. However, ask the people who have been laid off, facing or faced foreclosure, dealing with over-indebtedness, etc. if the recession is over in their lives. Statistics say one thing and reality says another. At the end of the day, I don’t think that the Great Recession of 2007 is going to get the press it deserves.

However, these favorable statistics do make for good political sound bites.

    State of the Stock Market

I would state that this is an important week for the stock market. The market has bounced back nicely in September and is at a 4 month high. Further, it has also risen past some key levels. However, it also has done so on very light volume which is not the sign of a healthy market. If the market starts a significant decline from these levels, I would not automatically assume it is just a pullback. I would take it seriously.

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Why hasn’t the economy recovered? Why are there still issues? This week I want to give you an economics lesson. If you can get an understanding of economic cycles, you can get a sense of where we are today.

We can get some insight by taking a look at how a normal economic cycle works. A normal economic cycle goes through 5 stages. The economic cycle starts at the bottom with a recession. Then you start a recovery that leads to a period of prosperity. When the period of prosperity hits a peak, a period of contraction occurs. During contraction, the prosperity period (economic growth) starts to slow down. If the contraction is severe then the slow down becomes economic loss. Economic loss leads to the next stage – recession. The recession acts as a detoxification period. The Government intervenes and then the recovery starts again which leads to a period of prosperity. The economy has been doing it that way for decades.

During a normal economic cycle, the government is effective in providing solutions. The government can intervene, fix things, and shorten the time it takes to get back to economic growth. In order words, the problems that created the recession can be easily fixed.

If we are not in a normal cycle, the cycle has grown much larger, meaning that it takes longer to move from stage to stage. This type of economic cycle is full of structural problems. For instance, the debt feuled prosperity period for this economic cycle was much larger and because of that the downturn is much larger. If that circle gets pushed far enough out, then the economic cycle could result in a much worse scenario like a depression or hyper inflation. It is an economic cycle that has gotten out of balance.

When you get into an abnormal economic cycle, you find the economy has structural problems. Said another way, it is the structural problems that create the abnormal economic cycle. With our current scenario, an irony exists. The very thing that created the growth in our country is the very thing that is creating the problem – DEBT. We were fueled and are being destroyed by the same thing. That creates more and more structural problems. A debt fueled recession or worse is the toughest thing to fix because in an abnormal economic cycle the Government cannot just fix things. They are ineffective as we have witnessed over the past few years.

The problem is only fixed through the destruction of debt. Either the debt is paid back or someone takes a loss. Since the government refuses to allow this to happen, the circle gets bigger and bigger pushing real recovery off into the future.

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The jobs number came out on Friday and the market loved it. The Saturday Edition of the Wall Street Journal proclaimed:

Jobs Data Provide Hope

I have always been a little gun-shy about the word “hope” given its link to our commander-in-chief. I honestly think that the markets are a joke sometimes. The market celebrated that 67,000 private-sector jobs were added last month. Of course, the total number of jobs for the month of August showed a loss of 54,000 jobs. Then there is my favorite number of all – the birth/death ratio.

This is the number of jobs that they “estimate” were created or were lost. I wonder what the jobs number looks like if you take out the 115,000 jobs that were created out of thin air? That is how many jobs they added back into the total. Now it wouldn’t be any fun if we didn’t look at how many jobs the Government estimated were created in the leisure and hospitality sector. After all, Americans have so much money to spend on these types of things. These companies must be hiring like crazy. (Please note the sarcasm.)

This past month 23,000 jobs were added to the leisure and hospitality sector. Thus far this year, the birth/death formula has added 421,000 jobs to the numbers. Of those, 78% were in the leisure and hospitality sector. I seriously cannot make this stuff up.

Are you starting to see what a joke Government accounting is? Let’s switch over to what Barron’s wrote this weekend about the jobs numbers and you will see a much more dire situation. From the article:

• All of the employment gains were part-time—full-time employment, according to the Household Survey, plunged 254,000.

• Those working part-time did so pretty much because they had no choice, and their numbers surged by 331,000—the biggest increase in six months.

• Of the 67,000 rise in private-sector jobs, 10,000 reflected returning construction workers who had been on strike.

• The 27,000 shrinkage in manufacturing slots and flat total goods-producing employment are hardly evidence of a vibrant economy.

I don’t need to tell you that this is a serious problem that isn’t getting the attention of the truth. It is just a bunch of politicians crunching numbers to create the fantasy and illusion that serves them best.

Needless to say, risk is very high in the markets. This is especially the case as we enter into the Bear’s favorite month of September.

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