In the last issue, we forecast that “at the end of September [the mutual funds cash-to-assets ratio] was likely down to 3.8% or worse.”     The ICI’s September update confirmed we nailed it—3.8%.  We are compelled to reiterate, the only lower readings were from March to September 2007, one of the most significant tops in market history.  Given the continuing advance in prices, it is possible that the ratio is now quite near the all time low of 3.5% in June & July 2007.  Yet another cycle of manic behavior by portfolio managers is simply totally ignored by the financial media.  There is a vast complacency visible on the TV news and in print, a gestalt that reiterates the probability of economic recovery and higher stock prices with almost zero concern for the failing fundamentals.  On one hand, the stock market seems to be forecasting a bright Christmas and robust retail sales.  But as we show on our chart on page three, bottom left, retailers have likely discounted quite the opposite.  Why wouldn’t they?  Jobs are still being shed at a distressing pace.  Unfortunately, there is ample precedent for another dip into recession.  Lower prices should lie ahead.       
 

Amazingly, notional values of derivatives have continued to grow, and reached $203.5 TRILLION by the end of the second quarter of 2009.  While the ratio of notional values versus total stock market capitalization has contracted nominally from 18.9 to 16.6, the ratio of notional values versus gross domestic product has risen from 14.1 to 14.5.  Only a decade ago, those respective ratios were only 2.0 and 3.6.  We’re not talking just “growth” here, we are looking at a runaway train.  Is there anyone in the world who believes this pace can continue?  Extrapolating at the rate of the last five years alone, in another five years, notional values of derivative products would total $560 trillion.  If GDP grows at 5% per year, the ratio of notional values to GDP would reach a staggering 30.8.  Ian McAvity (see http://www. topline-charts.com/Deliberations.htm) has pointed out many times how economic growth has been fueled by the rapid expansion of debt in America, positing that every dollar increase in GDP requires at least $3.50 in new debt [NOTE: McAvity computes that recently, every dollar of growth has required as much as $7 in new debt].  If that pace can be sustained, then surely pigs can fly.  But we digress….

We strongly urge subscribers to revisit the March 30th issue, “Evidence That The Retail Sector Is Sold Out.” [see http://www.cross- currents.net/z033009k.pdf]  Our page one chart showed that insiders had pulled back dramatically from their normal stance.  The top ten retailers as represented in the Retail HOLDRs Trust (RTH) sold only 1.83 million shares in the previous six months, as opposed to an average of roughly 10-1/2 million shares in our previous five tallies dating back to December 2006.  The RTH bottomed on March 6th at $60.23, 13 days before our chart was created and our premise that the sector was sold out was clearly justified.  By October 20th, the trust peaked at $93.96, a 56% rally.  

However, as our chart below illustrates, insiders were already beginning to expand their selling by an interim tally in August.  By last Friday, when we again tallied the stats, insiders sales over the prior six month period had exploded to 16.3 million shares, almost nine times the rate in the spring!  Apparently, the environment has changed.  What was cheap is no longer cheap and the logical inference is that going forward, the economy is not expected to be all that robust.  Given the third quarter GDP report and all the accompanying hullabaloo about the end of the recession, the chart below implies either a flat economy or even a double dip into recession.  Look at the comparisons; the only two other late year tallies were in 2006 and 2008 and selling was relatively restrained in both.  Clearly, retailers are selling their shares in droves and only weeks before the beginning of the holiday season that accounts for 30% of all retail sales.

As well, analyst ratings have ticked up markedly and if there’s any metric we might dismiss as utterly contrarian, that would be analyst ratings.  As prices in the sector moved up 56%, analyst sell ratings dipped from 6.8% to 3.9%.  Buy ratings have surged, from 47.5% to 61.2%.  The RTH was above the current share price for much of the four year period from 2004 to 2008, when GDP averaged 4.7%.  Is the retail sector a buy now?  With even the huge stimulus only capable of 3.5% growth, the sector is now overbought and has likely topped.     

ABOUT ALAN M. NEWMAN

Alan M. Newman has been the Editor of CROSSCURRENTS since the first issue was published in May of 1990. Mr. Newman is also a member of the Market Technician's Association and has been widely quoted for years by the financial press, media, and other newsletters and has written articles for BARRON'S.

The newsletter is published roughly every three weeks and focuses on economic and stock market commentary, often covering controversial subjects. Several proprietary technical indicators are usually featured in every issue accompanied by current interpretation.  Broad samples of our work can be viewed at http://www.cross-currents.net/ . 

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