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Are the Markets Overheated?

NYSE Trader
AP
NYSE Trader

A month ago, I wrote that money flowing into and out of mutual funds and ETFs is often a reliable indicator of what’s going on in the market.

(You can readthe post here .)

I introduced you to Charles Biderman of TrimTrabs, which tracks these fund flows.

At the time, his data was signaling a continuation of the pullback that had taken the S&P 500 from 925 to 880. Since then, we’ve seen a rally that wouldn’t quit – until the first couple of days this week.

If the latest run really is over, at least for the moment, it would not surprise Charles, who stands by his negative position. His latest report acknowledges he has missed part of this move, but he remains adamant, and I thought you might be interested in some of his latest observations.

He writes:

“We have unsuccessfully called for a major correction in global equities for several months. Despite the ongoing rally, most of our liquidity indicators still suggest equity markets are overheating:

“European companies have sold $190 billion in stock so far this year, which is comparable to what was sold at the 2000 and 2007 market peaks. In addition, both Enel ($11.4 billion) and Standard Chartered ($1.7 billion) announced large cash calls.

“Chinese IPOs are stirring the kind of frenzy we observed in 2007 and 2008. The Everbright Securities’ IPO was 142 times oversubscribed despite the shares’ lofty P/E ratio of 58.6.? In China, 824,580 retail trading accounts were opened in the last week of July, the most since January 2008.

“Corporate buying is plummeting. Stock buybacks are close to zero in Europe and Canada and are falling in Japan and Hong Kong. There are few cash takeovers, and we do not expect merger activity to pick up.

“Foreign buying of Japanese and Indian stocks is soaring. Similarly, U.S.-listed mutual funds investing in Asia-Pacific have posted an inflow equal to a stunning 33% of their assets since the March lows.

“Retail investors are heavy buyers of equity mutual funds in the U.K and Italy.

“Bubbles can be painfully long for value-oriented investors, but the fundamentals always prevail. The strength of this rally does not change our bearish view on global equities, so we remain neutral.”

Charles’ evidence and analysis are often right on target.

At the moment, his negative view is seemingly at odds with hints that the recession might be about over.

The market has clearly anticipated this, but the key question now is whether the market has priced in too robust a recovery. If so, Charles could be proven right, even in the face of an improving economy.

But it is very dangerous to get in front of a momentum train. As one of the top salesmen at a leading investment bank desk told me recently, this market wants to go higher. Oftentimes, no matter what the data show, momentum is tough to break. And even with temporary declines, investors must also be aware of momentum and sentiment.

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Questions? Comments? Write toinvestoragenda@cnbc.com

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