We have discussed measures of market sentiment on many occasion. These measures take the pulse of the collective mood on the part of a particular investor group. Sentiment is merely a function of human nature and when it becomes one-sided, it is an indication that the tide is due to turn. In general, when such measures reach an extreme in bullishness, the market typically struggles afterward. Conversely, when bearishness becomes pervasive, the market is prone to rally.
As we have mentioned before, there are two different types of sentiment indicators: surveys and real-money indicators. Surveys ask respondents how they feel about the market’s prospects, whereas real-money gauges reveal what investors are actually doing with their money. We prefer the real-money measures as they are more reliable. Money talks, as they say.
One such real-money measure of sentiment regarding the stock market is the amount of money allocated to bearish instruments, whether as hedges or outright downside bets. One of the categories of bearish instruments we track is that of “inverse” or bearish mutual funds, i.e., funds that go up when the market goes down. One of the oldest providers of beaish mutual funds is the Rydex family of funds, now owned by Guggenheim. We like tracking the amount of assets in these funds as a gauge of sentiment, particularly given the amount of history behind them. That history makes the fact all the more significant that the number of assets in Rydex bearish funds yesterday sank to an all-time low.
Specifically, the series in the chart consists of the combined assets of the 4 Rydex bearish funds that have existed since 2000. That figure dropped yesterday to just $112 million. For reference, the all-time high was set in February 2002 at $2.1 billion. This indicates that A) traders and investors in mutual funds have little concern regarding the prospects of a market decline and B) their portfolios are ill-equipped to handle such a decline.
Now, with every study there come caveats or mitigating factors to the message. It is no different with this data point. First, and most importantly, there has been a structural decline in the amount of assets in inverse mutual funds over the past decade. This is due directly to the proliferation and growing popularity of inverse ETF’s. More traders are opting for ETF’s as a hedging vehicle than mutual funds. That is a big reason for the all-time low in Rydex bearish funds.
That said, there are shorter-term fluctuations in these assets that still make the gauge useful as a sentiment indicator. For instance, as recently as October, these assets were nearly double what they are now. A year prior, they were triple what they are now. And as recently as the fall of 2011, these funds had nearly $700 million allocated to them.
Another (slightly) mitigating factor is that bullish assets have also come down just recently. In fact, they are down some 25% from their high in late November when we last highlighted Rydex assets. However, that still leaves them near 7-year highs, so that’s not a whole lot of comfort for the bulls.
The takeaway is pretty simple. While there has been a structural trend away from inverse mutual funds and toward inverse ETF’s, this is still a milestone low in the amount of assets in Rydex bear funds. Adjusted for that structural change or not, an all-time low is an all-time low. Furthermore, we have not witnessed a relative recent surge in the amount of bearish ETF assets. Therefore, the conclusion has to be that investors are likely very poorly positioned currently as it relates to their ability to withstand a significant market decline.
Photo by Ron Niebrugge, WildNatureImages.com
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