Q: Hi, Rex! Years ago, there was an indicator that showed how much cash was on hand among mutual funds (by percentage), and when there was a lot of cash, that would signal a bottom, though it was a lagging signal - the information was not readily available. I notice that the monthly cash flow into mutual funds on a monthly basis seems to indicate the tops and bottoms rather strongly. What do you think?

A: There are a number of strategists, technicians and pundits who track mutual fund cash flows. I have felt that measurements of mutual fund cash on hand have become less reliable as a sentiment indicator in recent years for several reasons.

1. Most mutual fund portfolio managers these days use derivatives (index options and futures) to hedge their portfolios while remaining nearly fully invested, so actual cash on hand might not be a good measure of their bullishness or bearishness, unless you happen to know at the same time what they are holding in derivative positions.
2. After the crash of 1987, most mutual funds developed lines of credit with the banks to avoid having to sell their positions in an illiquid market to meet redemptions. Unfortunately, we have no way of knowing how much of the line of credit is being used at any given point in time.
3. Several years ago, Jeff Vinik (former portfolio manager for the Fidelity Magellan Fund) was fired because he moved 30% of the portfolio into cash and bonds because he was worried about the markets. That event has caused most mutual fund portfolio managers to stay fully invested, no matter what they think the market might be doing, just so they can keep their jobs. Instead of an absolute return, they are now targeting a relative return, comparing themselves to a specific benchmark index. Since an index is, by definition, fully invested, it forces the portfolio manager to be as nearly fully invested as possible as well.

In conclusion, I think you have a good idea, but as in many things in trading, things are often more complicated than they seem at first glance.

Rex Takasugi

Q: I've always sort of struggled with the difference between MACD and the PPO. Why exactly do you folks seem to favor the PPO over the MACD? I've tried to comprehend when they would diverge on my own, but my feeble lil mind don't seem up to the task.

At the moment, PUMA has re-raised this question. There is a clear difference between the MACD and the PPO for PUMA. The MACD has a slight positive divergence while the PPO has a distintly negative one.

A: MACD is the absolute difference of two moving averages and the PPO is the percentage difference. Here's an example to show the differences using the 12 and 26-day exponential moving averages.

12-day EMA = 40
26-day EMA = 50
MACD = 40 - 50 = -10
PPO = (40 - 50) / 40 = -.25 or -25%

Assume the stock declines sharply over the next few weeks:

12-day EMA = 20
26-day EMA = 30
MACD = 20 - 30 = -10
PPO = (20 - 30) / 20 = -.50 or -50%

Even though the stock is obviously declining at a faster rate, MACD still registers -10. This is because MACD measures the absolute difference between the two moving averages. However, the PPO, which considers the percentage difference, more accurately reflects the accelerating decline and has moved to -50%.

(Current Chart for PUMA)

The PUMA example reflects the above scenario. The PPO recently declined below its August and September lows. However, MACD remains above these lows because the absolute price of PUMA was significantly higher a few months ago.

Hope this helps
Arthur Hill