Brace Yourselves For A Market Pullback. Another Market Metric Signals A Potential Top

Mutual funds are currently holding a record low level of cash, according to a recent report from iconic Wall Street bank Goldman Sachs GS .

That probably means that investors should brace themselves for a drop in the stock market.

The level of cash being held by U.S. mutual funds, which specialize in holding stocks, dropped to 1.6% on August 26, down from around 3% in 2016. The historical average is 2.5%, the report states and describes the current level as a “record low MF [mutual fund] allocation.”

Extreme Readings in Mutual Fund Stock Holdings

Put another way, equity-mutual funds own a higher portion of stocks than ever.

On Wall Street, extreme readings, such as record lows or highs of holding a type of asset, are often seen as contrary indicators. When everyone is bearish on stocks, then it’s time to be bullish, for instance.

Or in this case, when the level of cash held in mutual funds is at a record low, that could mean that the market is cruising for a bruising.

When everyone is as bullish on stocks as they have ever been then may be it is time to sell, or at least trim the portion of stocks in favor or other assets. Why? Because when the last buyer has bought into a stock rally, then there are no more buyers left. Without new buyers there is no impetus for the market to continue rallying.

Of course, mutual funds are just one way of buying into the stock market, but the indicator is a useful one, especially when combined with others.

Given that markets are also reaching record highs, this might be a time for investors to be cautious with their holdings. That can get done a number of ways including the following:

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  • Selling a portion of stock holdings in favor of high grade bonds
  • Holding dividend payments in cash instead of reinvesting them immediately
  • Buying S&P 500 index out-of-the-money put options which pay out if the market falls substantially.

Of course, investors with a long term time horizon for their portfolio may wisely choose to ignore the prospect of a market pullback based on the idea that the major stock indexes tend to trend higher over long periods of time. In fact, for most people, just sit tight, might be just the advice investment advisors would give.

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