(Editor's Note: This article was written on June 16th - over a week ago. Given the market's sideways motion since then, the article's basic premise remains valid. It is also instructive to compare commentary from the past with current conditions to see how the commentary "played-out".)
Despite a massive rally on Thursday, the Rydex Cash Flow Ratio reflects that very few bears have given up. The Rydex Cash Flow Ratio, an exclusive DecisionPoint.com indicator, 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. While the Ratio is not necessarily representative of the entire stock market (it only involves money in Rydex mutual funds), it has proven to be a reliable sentiment indicator.
Our first chart shows that the Ratio is at the low end of its range, meaning that bearish sentiment is at an extreme level. Note that Thursday's rally only effected a small up tick on the Ratio, so very few bears have been shaken loose. This is bullish for the stock market because short-covering bears are like rocket fuel for rallies.
Our second chart shows how the recent rally was in fact a bounce off the bottom of a rising trend channel. That means the support, so far, has held, and that is also bullish. Additionally, most of our medium-term indicators are oversold, providing a good foundation for an extended rally.
Bottom Line: Our primary mechanical timing model remains neutral, and it will take continued constructive market action to turn it back to bullish. An excess of bearish sentiment and generally oversold market conditions provide a good setup for a rally; however, I must emphasize that oversold conditions are very dangerous if the bull market is transitioning to a bear market. For planning purposes, I will assume that the rally will continue, but my market posture will remain neutral pending a buy signal on our timing model.
