NazT..your take on this article please..
September 4th, 2003 9:00pm ET
Back in my August 19th commentary, available in the archives, I presented the
track record of every short signal generated by the Institutional Money Flow
(IMF) model since 1997. For those unfamiliar with the IMF, it's a long-term
market timing strategy based on the positions of institutional investors in
S&P500 futures. When institutions are long, the IMF is in a buy mode and will
remain so until institutions go short, at which point the IMF switches into a
sell mode. This simple but effective strategy has an enviable track record at
forecasting the long-term trend of the stock market. It went short just prior
to the 1987 crash, covered and went long soon thereafter and stayed long
throughout most of the 90's. More recently, it went short again at the market
top in May of 2000, covered the short in March of 2003 and went long. In other
words, it's caught virtually every major move up and down in the market over
the past two decades, a record of performance that cannot be ignored. The most
recent signal was a short in late June of this year at SPX 976. In each of the
21 prior short signals generated by the IMF since 1997, the S&P500 has never
moved more than 9% against the spot at which institutions initially
established their short positions (in other words, the maximum drawdown never
exceeded 9%). In at least half of the prior short signals, the S&P moved
against the IMF signal by at least 3%, meaning it's not unusual to see the
market continue moving higher despite the sell signal. What is highly unusual,
however, and in fact has never happened in the history of prior short signals,
is a 10% drawdown. That's a key point to keep in mind, because the S&P is up
approximately 5% since the June 27th short signal. That suggests the market is
running out of room on the upside. This chart, which I showed last month,
illustrates the potential 'drawdown zone' for the current short, and shows
where the S&P shouldn't trade - SPX 1075. The reason is that level represents
a 10% drawdown from the late June short, and history tells us the S&P won't
trade above that level before this short signal is closed out. Based on the
massive amount of contracts institutions are holding short (currently over
60,000 S&P futures contracts), it'll probably be sometime next year before the
short is covered, most likely coinciding with a significant decline in the
market. That means investors with a longer-term horizon should be viewing the
current rally as a rally to short into, rather than worrying about when or
whether they should jump in on the long side. The 'line in the sand' is SPX
1075. If the S&P trades above that level, we're in uncharted territory as far
as prior IMF short signals are concerned, and there's no telling how high
it'll go. But odds are good we won't see the S&P make it that high, and that
means the area between SPX 1025-1050 should be viewed as a longer-term sell
zone with a 1075 stop. In so doing, you're risking somewhere in the 3-5% range
for a long-term trade that could generate returns five to ten times that
amount. I say that only because the last time institutions were this heavily
short was in May of 2000, and by the time the shorts were covered, the S&P had
fallen over 35%. That makes even a 5% risk seem fairly attractive.
When the IMF short was originally triggered back in late June, I was less than
enthusiastic about it, and discussed in a number of columns the fact that one
key long-term indicator was not only not backing up the IMF short signal, but
was actually implying further upside lay in store. That indicator was the
Specialist Short Ratio. The following quote is from my July 15th column...
"Until we see [the specialist short ratio] move above 35% (back to more
typical levels), the market will most likely hold above SPX 975 as specialists
remain heavily long while the public remains heavily short. Institutional
investors in S&P futures are also heavily short, which is a longer-term
bearish sign, but we need to keep in mind that the Institutional Money Flow
models can be early. We have historical charts of the IMF going back over a
decade in the charting section of the website, and if you look back at the
relatively few times in which the IMF was short for a number of weeks, as is
the case now, you'll see the S&P has the potential to rally anywhere from 5-
10% before a selloff ultimately begins. The most glaring case was back in May
of 2000, when institutions went heavily short and continued to add to their
shorts while the S&P staged a three-month rally that took it up approximately
9%. Ultimately, it was a great sell signal that lasted nearly three years, but
you had to be extremely patient for the first six months. Currently the S&P is
up less than 3% since the latest IMF sell signal was triggered at the end of
June. To get a sustainable move to the downside, we need to see those short
positions on the NYSE change hands. Typically, the only way this happens is
via a sideways to up stock market (like we have now), which frustrates the
typical investor into covering shorts. We'll know this is occurring on a mass
scale when we see the Specialist Short Ratio make a move back over 35%, and
preferably back over 40%. The 40% level is significant, because we've never
seen a major drop in the stock market that wasn't preceded by a specialist
short ratio over 40%. With the current ratio standing at a very low 29.6%,
this indicator suggests the potential for a persistent short covering rally
that will last until short positions move from the weak hands to the strong. "
The Specialist Short Ratio (SSR) rose back over the 35% this past week, ending
the long two-month buy signal triggered by this indicator back on June 27th
when it initially fell below 35%. This implies that investors have indeed been
getting blown out of their short positions during this breakout into new
highs, which sets up the potential for a longer-term move to the downside once
a sufficient percentage of shorts held by the 'public' are covered. Currently
the SSR still stands at a relatively low 36%, and if you look at this long-
term chart going back a decade, you can see we're still closer to historic
lows than historic highs. As I discussed in Tuesday and Wednesday's column,
the myriad of bullish setups triggered recently suggests the market will
remain in a sideways to up pattern until options expiration later this month,
so it doesn't appear that there's any great rush to establish shorts. I
suspect that the persistent strength in the market will cause the Specialist
Short Ratio to continue moving higher in this period of time, as more and more
investors are squeezed out of their shorts. Ideally, the SSR will move above
the 40% level before the end of the month, and assuming the IMF remains in
bearish territory, it would set up what could be an ideal longer-term entry on
the short side.
astrikos.com
