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The Third Indicator:  Performance of Sectors
It is well known that each stock market sector has its forte at a specific time during the business and stock market cycles. This is commonly known as “The Sector Rotation Model” (SRM). Peter Navaro’s book “When the Market Moves, Will You Be Ready?” ([2]) covers this subject very well and it is my recommendation for those who wish to find compact and decent information on the model. From a hardcore view of fundamental analysis, one should try to identify the current position of the economy in the business cycle, then project this position in the stock market cycle and finally identify the sectors that will likely outperform the market in the near future. A different more technically oriented view is to reverse the previous method and use the sectors performance to identify the current position in the stock market cycle. Since the SP500 index is regarded as the most reliable proxy for the US stock market one can use the SP500 sector exchange traded funds (ETFs) to accomplish the latter.

Figure 3 illustrates the sector ETFs that are likely to perform well during the various phases of the stock market cycle according to the SRM. Study figure 3 carefully and then take a look at figure 4 where the percentage change between the end of September 2007 and the end of December 2007 is shown. Now go back to figure 3 and identify the position in the stock market cycle (black curve) which should correspond to the data from figure 4. It should be readily apparent that the SRM sends bearish signs about the stock market.

The Fourth Indicator: Cash Levels of Mutal Funds
Mutual funds (MFs) are among the big players in the stock market game and their positions and intentions admittedly affect the performance of the stock market. Each month the Investment Company Institute releases information reports regarding the US mutual funds industry. Amongst the various important issues one can find in these reports is the liquid assets of MFs (also called cash levels). According to Larry Williams ([5]) when MFs are sitting on a great deal of cash on a relative basis it means they can buy and push the stock market prices higher when they have very little cash on hand it’s very difficult for stock prices to go higher. This is not a new idea. It is based on a fundamental tenet of trading: “when all are on the bullish side no one is left to buy”.

By this token, take a look at figure 5 where the aggregate raw cash levels of the MFs are shown from 2001 to the mid 2007. The figure is clearly disappointing as it shows that the MFs are heavily loaded and have the least cash on hand relative to the past.

The Raw Results
A simplistic study of commercials, insiders, sector rotation and mutual funds cash levels do not seem to produce a meaningful answer about the prospects of the stock market for 2008. The activity of commercials and insiders implies a strong market while the performance of sectors along with the mutual funds cash levels sends serious bearish signs.

A More Sophisticated Approach
While the raw study of the four indicators gives no straight answer I have the impression that a more detailed look puts more ticks in the bullish side and this is for a couple of reasons. First, the commercials and insiders are by definition those who know better and their activity must be taken more seriously into account. Their bullish attitude during the last months of 2007 is remarkably unusual and reasonable implications from this attitude have not surfaced yet. The performance of sectors on the other hand is a combination of all market participants making the third indicator a little less significant. Second, a long term falling cash level of mutual funds alone does not seem to have the strength to reverse a bullish market (take a look at the trend of the cash levels of MFs from 2003 and thereafter in figure 5). Also, the fact that the mutual funds are heavily loaded with respect to their assets does not mean that they will not have fresh cash to invest if new individuals give them their money which leads to the third reason: the massive entrance of the general public. Beginning from 2003 we have faced a remarkable bull market but in my opinion we have not yet seen a wider distribution of stocks to the general public.

In Conclusion
I tried to cover and analyze the performance of four of the most significant stock market indicators during the last months of 2007. Two of them gave bullish signals and two of them gave bearish signals for the beginning of 2008 but in terms of quality I believe the weight is more on the bullish side. In any case, all the indications require confirmation from the market and this is where technical analysis comes in. During the last months of 2007 the stock market is fluctuating trying to find a direction and the strong multiyear uptrend that started in 2003 is in serious danger. The technical signals in the broad stock market indices will give the final answers. One thing is for sure however: This unusual coexistence between extreme readings in the four indicators and its implications should be noted for future reference when similar situations emerge.

Staying Up to Date
There are subscription sites where most of the data I have presented here is available in a convenient form. You can however monitor the indicators for free on the Internet as all of the data is publicly available from official and unofficial sites.

REFERENCES

[1] Muzea, George, The Right Stock at the Right Time: Prospering in the Coming Good Years, Wiley (2004).
[2] Navarro, Peter, When the Market Moves, Will You Be Ready?, McGraw-Hill (2003).
[3] Seyhun, Nejat, Investment Intelligence from Insider Trading, The MIT Press (2000).
[4] Williams, Larry, Trade Stocks & Commodities with the Insiders: Secrets of the COT Report, Wiley (2005).
[5] Williams, Larry, The Right Stock at the Right Time: Prospering in the Coming Good Years, Wiley (2003).