An Enviable Track Record

An Enviable Track Record
Adjusted Mutual Funds' Cash-To-Assets Ratio Modestly Bullish

By Mark Hulbert, Marketwatch | 10 February 2010

ANNANDALE, Va. (MarketWatch)— I usually take a jaundiced view of an adviser's claim that his market indicator is one of the best ever. In fact, never in my thirty years of monitoring investment newsletters have I encountered an adviser who doesn't think his particular indicator deserves that accolade. But in the case of Norman Fosback and his so-called Fosback Index, it would appear that he has strong historical support to be at least considered.

Fosback, of course, is the editor of Fosback's Fund Forecaster. The indicator that he named for himself is a variant of the widely-followed mutual fund cash-to-assets ratio, adjusted to take into account prevailing interest rates. It "implicitly recognizes that fund managers have a profit incentive to own more interest-earning cash-equivalents when interest rates are higher and less when rates are lower," Fosback writes.

This adjustment is especially crucial right now, because the unadjusted cash-to-assets ratio right now shows mutual fund cash levels to be at record low levels. But, Fosback points out, while funds are holding a low amount of cash in absolute terms, it "is high in view of the miniscule money market interest rates, which give the funds no incentive to hold interest-earning cash assets".

How has this indicator performed in the past? At the stock market top in October 2007 it was "extremely bearish" (Fosback's words from the last issue received before that top). In fact, it was as bearish then as it had previously been at the market tops in 2000, 1981, and 1972. It furthermore turned bullish in early 2009, just before the bear market's March 9 low, reaching its most favorable reading in 17 years. Fosback declares his Index to be "the single best cyclical market indicator in existence".

Furthermore, unlike many other market timing models being circulated today, the Fosback Index is not the outcome of a data mining exercise in which the data is retrofitted after-the-fact to a new model that no one had ever heard of before. On the contrary, Fosback introduced the index in his book Stock Market Logic in 1975, 35 years ago.

What Is The Fosback Index Saying About Today's Market?

I thought you'd never ask It turns out that the indicator's current reading contains both good and bad news. The good: The Fosback Index remains in positive territory. The bad: It has fallen fast in recent months, and is nowhere near as bullish as it was a year ago.

In fact, Ned Davis Research now rates its variant of the Fosback Index as no better than neutral. The firm has calculated the track record of its version back to 1960, and reports that the S&P 500 index (SPX 1,068) has produced a 13.9% annualized return since then in those months in which it is above 1.13. That contrasts to a 0.2% annualized loss during those months in which the indicator is below 0.75.

When the indicator is between 0.75 and 1.13, the S&P 500 has gained 2.9% annualized. That's the range most relevant to today, as the Ned Davis version of this indicator currently stands at 1.03. Your interpretation of this will depend on what you previously believed about the market's likely course from here. The bears among you will find little outright support from the Fosback Index, since it is not flashing the extremely bearish signals that it was in October 2007. But, by the same token, the Index is nowhere near as bullish as it was in March 2009, and is instead in a range more consistent with far more modest market returns.