Friday, January 9, 2009

Rydex Asset Data: Leveraged Bulls v. Leveraged Bears

I have presented a lot of data recently suggesting an intermediate term top for equities, and the weakness in prices this past week seems to be consistent with that view. Just as investors begin to embrace the hope that better times are coming, it's "bam" back to reality. This is still a bear market - sell hope, buy fear.

I have been reluctant to present the Rydex asset data for two reasons. One and as stated above, I have already presented enough data as to why I thought the market would stall at this juncture. Two, I have less confidence in the Rydex data due to the changing nature of this data set. Nonetheless, a reader asked me about the data, so here we go.

The Rydex Mutual Fund company provides data on how much money is going into each of their funds, so in this sense, we can see where investors are putting their own hard earned cash. In general, investors and traders have found the Rydex asset data useful as a contrarian tool. If, for example, there is too much money going into their money market fund, it means that Rydex investors are fearful of further stock market losses. So this would be a time to get long. The other thing useful about the Rydex Mutual Funds is that it allows investors to bet with or against the market and if their conviction is strong enough, the Rydex investor or trader can use leverage.

So why have I lost confidence in the Rydex asset data? Honestly, I am beginning to wonder whether it is still useful as a contrarian tool. Typically, I would bet against the Rydex investor as from 2002 to the end of 2007 it represented the "dumb money". Starting in 2008, betting with the Rydex investor has been a better strategy.

Why might the Rydex asset data become the "smart money"? I suspect it has to do with the proliferation of leveraged exchange traded funds seen over the past year. Prior to these ETF products, Rydex was one of the only games in town that allowed the use of leverage, that allowed intraday trading of their funds, and allowed betting against rising prices in the market. These features made Rydex unique until the new leveraged ETF's came along. To support this notion as to why the Rydex data might no longer be relevant is that the amount of money in their funds has decreased by about 30% in 2008 alone. Maybe the only money left at Rydex is the "smart money". Of course, only time will tell if this notion of mine is correct. Data like the Rydex asset data have a tendency to change as the times change. What was once considered extreme is no longer. Investors and markets change. Money finds another home.

As per the reader request, I present the amount of leveraged assets in the Rydex bull oriented funds versus the amount of leveraged assets in the bear oriented funds. Despite my concerns above, this is one of my favorite Rydex indicators. Not only can we see how these market timers are betting on market direction, but we can also see if they are doing so with conviction (i.e., leverage). Figure 1 is a weekly chart of the Power Shares QQQ Trust (symbol: QQQQ). The middle panel is the actual data of the Rydex leveraged bulls (green) v. leveraged bears (red). The indicator in the bottom panel takes the rate of change of this ratio and then looks for extremes in this value over the prior 52 week period.

Figure 1. Rydex Leverage Bull v. Leverage Bear

As you can see, the indicator has been above the upper band for several weeks now. Prior instances of the indicator being above the upper band have generally resulted in an intermediate term top or sideways movement of prices. These are noted with the purple vertical lines. Figure 1 looks at the period from December, 2004 to the present. Figure 2 looks at the period from December, 2001 to December, 2004. With the exception of April, 2003 (which was the blast off for the bull market), this indicator has done a very good job at identifying intermediate term market tops.

Figure 2. Rydex Leverage Bull v. Leverage Bear

So let's summarize. I have presented more sentiment data suggesting an intermediate term market top. Going forward, I still need to monitor the usefulness of the Rydex asset data.


Biscosc said...

Another fantastic post, thank you! I'm curious if you've ever done any research into the Rydex cash flow ratio that Decision Point created? They did an interesting post back in November where they showed the asset ratio looked bullish but the cash flow was very bearish. I have a feeling you've probably already seen the article but just in case here is a link:

Guy M. Lerner said...

Thank you for the link. As stated in the article, I have been losing confidence in the Rydex data; I still follow day to day but sometimes I wonder who is the smart money and who is the dumb money.

Biscosc said...

After looking at the Rydex cash flow ratio graph compared to the Rydex asset ratio graph do you feel anymore confident?