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SENTIMENT JOURNAL: Jitters Rise as Tech Stocks Slide
By Frederic Ruffy, Optionetics.com
4/30/2004 3:00:00 PM

http://www.optionetics.com/articles/article_full.asp?idNo=10319

Technology stocks are falling and the Nasdaq Composite Index ($COMPQ) lost ground during all five trading sessions this week. In the end, the Nasdaq finished 130 points, or 6.3%, below last Friday’s levels. The greatest percentage losses have occurred among the networking, semiconductor, and internet stocks. The Dow Jones Industrial Average ($INDU), meanwhile, fell during four of five trading sessions to finish the week down roughly 250 points, or 2.5%.

Market jitters rose a bit during the market’s latest slide. The increase in market angst was visible in the movement of the CBOE Volatility Index ($VIX), which fell to new multi-year lows last Friday. On the week, the market’s so-called “fear gauge” rose from 14.01 to 17.19. At the same time, the CBOE put to call ratio rose to relatively high levels. On Friday, the ratio rose to 1.02. Readings above 1.00 from this ratio are relatively rare and indicate that put volume is increasing relative to call volume on the Chicago Board Options Exchange [CBOE], which generally occurs when investors are becoming more bearish or anxious.

While the VIX and the CBOE put-to-call ratio point to rising bearishness or anxiety among investors, some indicators suggest that investors remain relatively bullish or upbeat. For instance, the International Securities Sentiment Index [ISEE] rose above 200 two times this week. Readings above 200 indicate two times more call than put buying on the International Securities Exchange [ISE], the largest US options exchange. The relatively heavy call buying is a sign that options traders are still willing to place bullish bets despite the market’s recent slide. So the ISEE is clearly at odds with the recent rise in the CBOE put-to-call ratio and the VIX.

Meanwhile, the surveys of investor sentiment are also showing relatively high levels of bullishness. According to Investors Intelligence, 50% of those surveyed are bullish and only 22.4% are bearish. Similarly, the American Association of Individual Investors [AAII] reports 50% bullish and only 21.4% bearish in its latest sentiment survey.

Mutual fund investors are also bullish. According to the Investment Company Institute [ICI], stock mutual funds saw inflows of $15.84 billion during the month of March, which follows $26.2 billion of inflows in February. The pattern appears to have continued during the month of April. AMG Data reports that stock mutual funds saw $5 billion of new inflows during the past two weeks. Therefore, fund investors seem undeterred by the market’s recent slide.

In addition, mutual fund managers are also buying stocks. Recall that stock mutual funds are nothing more than pools of money. A portfolio manager controls these pools, or funds, and makes decisions regarding what stocks to buy and sell. According to ICI, at the end of March 2004, there were 4,621 different stock mutual funds in existence. Therefore, it is a competitive business and mutual fund managers that fail to produce superior returns often lose investors to competing funds.

In addition to deciding what stocks to buy and sell, fund managers must also decide on how much cash, or liquid assets, to leave in the portfolio. Managers must always have some cash immediately available, because if faced with redemptions (outflows when mutual fund shareholders exit the pool), they must redeem shares for cash—and not be forced to sell stock. Therefore, the percentage of liquid assets held in mutual funds is important because, if it is low, heavy fund outflows can lead to heavy stock selling as portfolio managers are forced to liquidate their portfolio’s holdings in order to raise cash.

The chart below shows the percentage of liquid assets held in the average stock fund over the past 19 years. It hit an all-time high in the early-1990s (12.89% in October 1990) and began falling. The percentage of liquid assets held in the average stock fund hit an all-time low in March 2000. At that time, it fell to 4%. Perhaps not by coincidence, that coincided with a major top in the stock market. March 2000, as we all know, was followed by extreme volatility. Now, the percentage is once again falling. According to ICI, it fell to 4.2% in March 2004 and its lowest levels in four years. That, in turn, sets the stage for more market volatility if, like in April 2000, fund investors turn bearish and begin selling mutual fund shares.