Bullish Signs on the Rise

Interest rate cuts, rising cash levels and an increase in bearish sentiment are setting the stage for an improved market

By Mark Arbeter

The Federal Reserve took some pressure off the market with a surprise 50 basis point cut in the fed funds rate on Wednesday and a 25 basis point drop in the discount rate. The discount rate was subsequently dropped another 25 basis points late Thursday. Fed funds futures are discounting an additional 50 basis point cut at the Jan. 31 meeting of Fed policymakers.

Over the last 30 years, monetary easings by the Fed have proceeded fairly healthy moves in the stock market. The latest round of rate cuts were in Fall 1998 -- and both the Nasdaq and the S&P 500 were sharply higher six months later.

The rate cuts have probably put a floor under the market at the very least but there have been no indications that a new upleg is in place. Previous lows for the Nasdaq have occurred when there is a positive divergence between the index and new 52-week lows. That is, the index will move to a new low while new lows will contract. This happened at both the lows in 1997 and the major low in 1998. The latest peak in new lows occurred on Dec. 20 with a reading of 16.7% (new lows/issues traded). The index has subsequently moved to a new low while new lows have not yet exceeded their 12/20 level.

The potential for a positive divergence is there, but it is too early to tell. To confirm that a new upleg is in place, up/down volume has got to show improvement over a five to 10 day period. That requires follow-through strength, which continues to elude the market.

The spark (rate cuts) for a market rally is here and fortunately, the fuel is also available. The mutual fund cash ratio has risen to the highest level in four years and now stands at 6.5%. This is up from only 4% in March 2000. There was a sharp reduction in the money moving into stock funds in November, which is also bullish, but it would have been even more bullish if there were outflows from stock funds. This did occur at both the bottoms in 1998 and 1990.

Aside from the cash levels held by mutual fund managers, money market assets are at a record level and seasonal inflows into the market are heaviest early in the year. The fire has been lit but the gasoline needs to be thrown on it.

Another sentiment poll went to a bearish extreme last week -- which is bullish from a contrary view. The Consensus poll, which measures bulls on stock index futures, has fallen to only 20%, the lowest level since May 2000, Oct. 1999 and Sep. 1998. The 1998 and 1999 timeframes represented major intermediate-term lows while the one this year occurred before a nice tradable rally.

Downside risk is low and the probability of an improved market environment is rising.

Arbeter is chief technical analyst for Standard & Poor's

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