No doubt there are some brilliant mutual fund managers, but only a few of them consistently beat broad market S&P 500 funds (VFINX.O).
The fund manager profession may consider this an insult, but viewed as a group they are often more valuable as contrarian indicators.
Mutual Fund Cash Levels
Just like a fire needs wood to burn, stocks need available cash to rally. Mutual fund cash levels are one gauge of ‘sideline money’ left to bid up price.
Historically, fund managers are close to fully invested near market highs and out of the market near market lows.
The chart below illustrates just that. Mutual funds (blue columns) were almost fully invested before the S&P 500 (SNP: ^GSPC) went into meltdown mode and held record cash positions when the S&P 500 (NYSEArca: SPY) took off in 2009.
In other words, investors were fully exposed to losses and held much cash at a time when they would have wanted to own stocks.
But enough beating up poor fund managers, let"s take a look at current mutual fund cash levels and the implication for stocks going forward.
As of June, mutual funds had 3.8% of funds invested in cash. This is somewhat near the all-time low of 3.3% in December 2012.
However, considering that the S&P 500 is trading higher than in December 2012 or any time in 2007, the current mutual fund cash level is actually not that alarming.
The 'Twist'
Another fact to consider is interest rates. In 2007 the 10-year Treasury Note yielded up to 5% while the 10-year yield was below 2% for much of 2013 (black line at bottom of chart).
In other words, the incentive to hold cash in 2007 was much higher than in 2013.
The red line at the bottom of the chart adjusts the mutual fund cash level for interest rates (mutual fund cash level : 10-year yield).
Based strictly on a balanced assessment of mutual fund cash levels, managers are not yet uber-bullish.
But mutual fund cash levels aren’t the only way to gauge what the pros are doing.
A little-known indicator provides a sneak peak at what mutual fund managers are thinking (and doing) and what it means for stocks going forward. Based on this indicator, fund managers are really buying into this rally. Is this a contrarian alert?
Follow Simon on Twitter @ iSPYETF.
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