The S&P 500 climbed to more than 20% above its 200-day moving average. It’s the first time in more than 20 years since that has happened. Some say it’s bullish momentum that should carry the market ever higher. Others say it’s a very bearish overbought condition that could lead to a collapse. So who is right?
I’ll let you decide for yourself. But here is my take: there is absolutely no evidence whatsoever that this extreme reading has any value as a forecasting tool. Sometimes the market goes higher (1933). Sometimes it goes lower (1929). And sometimes it just sits still (1975). Like I said, it’s of little use.
Click the link below to enlarge and/or download the table and chart.
Index Greater Than 20 Pcnt Above 200 Day Ma
I tend to be a contrarian. Contrarians believe that when the crowd thinks one way, the market tends to go the other way.
Thursday, Clusterstock posted an article on the net new flows in and out of long-term mutual funds. The preliminary data shows that September will likely have an outflow for the first time in 5 months. Some folks commented that this is a good sign, as it shows bearishness among investors, which is bullish to contrarians … like me.
But here’s the thing. I am not a perma-contrarian. I don’t believe that every example of investor opinion provides a contrary signal. Show me the data, and I can easily be persuaded that being a contrarian is not always the best idea. For instance, when I heard that we’re seeing outflows for the first time in 5 months, I thought, “Wow, that means we’ve been seeing inflows during the past 5 months, which have been five of the best performing months in recent market history! These mutual fund investors have not been wrong!”
I then went back to my database, which has monthly net flows going back to 1954, to see how this supposedly dumb money has performed over the past three years. Let’s just put it this way, based on the flows into and out of long-term mutual funds since the beginning of 2007, you don’t want to fade this group.
Here’s why: Let’s say you’re an investor and you’re going to create a system that is based on nothing but following the net new flows. Basically, this is the opposite of a contrary opinion strategy. If net new flows are positive, you go all in and invest in a stock index fund such as SPY. If net new flows are negative, you sell the index fund and wait till the net new flow turns positive. The one thing you have to realize is that there is a huge delay in the availability of the data. For instance, the final data for August won’t be available till the end of September.
With that in mind, how would an investor have done doing nothing but following this super-simple system? Quite well, thank you very much!!
Click image to enlarge
What this graph shows is that by doing nothing but following the fund flows, you’d have missed almost all the carnage, and profited from some of the gain. Had you gone short when the flows were negative, the profits would have been gigantic! Feel free to take a look at the data (the link is above). You’ll see that for 2007 and early 2008, flows were mostly positive. Then in June 2008, flows shifted to negative and stayed that way for months. That is, investors were mostly positive when the market was going up, then got out before the market crashed, at which point they started putting money back to work shortly after the market bottom, but before the huge summer rally. Nice job!
So is this a system you should follow? The next graph from a different time period should tell you all you need to know.
Click image to enlarge
During this six-year period encompassing 2 bull markets and 2 bear markets, an investor following net new flows would have been brutally whipsawed, completely missing out on more than a 100% gain in the stock market. And that’s the good news. Had they gone short when the flows were negative, they would have been wiped out! Pathetic.
So what does this mean? It’s pretty simple, and short; net new flows are worthless as indicators — contrary or otherwise.
BUSTED!
