How Much Cash is on the Sidelines?

According to Bloomberg, many investment managers are becoming optimistic about the future of the market because there is still a ton of cash not yet invested in the market. This money has been termed “cash on the sidelines” because it is really not earning a return, and people have stashed it away for a rainy day. As the bulls theory goes, there are two reasons that this will help drive the market higher. First, economic improvement and a return to growth will make investors less risk averse. At the same time, these cash-heavy portfolios will start allocating those safe assets into more risky investments in order to reap better potential returns.

Saving Money

Investors placed $1.45 trillion in U.S. money-market funds in 2007 and 2008during the worst financial crisis since the Great Depression, based on data from Washington-based ICI. The amount has dropped $439.5 billion since reaching a record $3.92 trillion in the week ended Jan. 14.

A broader measure of reserves that includes cash, bank deposits and money-market funds has climbed to $9.55 trillion this month, based on data compiled by the Fed. That’s enough to buy all of the companies in the S&P 500, which have a combined market value of $9.37 trillion, Bloomberg data show. Since 1999, so-called money at zero maturity has on average accounted for 62 percent of the stock index’s worth.

“There is a wall of cash,” said Yves Carpentier, a Paris- based manager at Cap West, who oversees $118 million in three U.S. stock funds that have gained more than 32 percent this year, beating at least 87 percent of their competitors. “Stocks will be the investment of choice in the coming months.”

Stock Inflows

Investors are returning to stocks faster than in the last bull market. They’ve added $15.8 billion to domestic-equity funds since March, compared with outflows of $18.6 billion during the first five months of the bull market that began in October 2002, data from ICI shows.

Should inflation exceed returns on money-market accounts, that may cause more investors to buy equities. The 100 largest taxable U.S. funds returned an annualized 0.12 percent during the past week, according to data compiled by Westborough, Massachusetts-based Crane Data LLC.

The Fed said on Sept. 23 that it anticipates keeping the benchmark interest rate “exceptionally low” for an “extended time.” Labor Department reports this month showed prices of goods imported into the U.S. tumbled 15 percent in August from a year earlier and consumer prices dropped 1.5 percent.

“Many of the fund managers I talk to that have missed this rally or underplayed this rally are sitting with way too much cash,” said Jeffrey Saut, chief investment strategist at Raymond James & Associates in St. Petersburg, Florida, which manages $214 billion. — 9/28/2009

So, the fact that there is a net inflow into stocks is an encouraging sign coming out of the worst financial crisis since the Great Depression. It shows that investors are willing to take on more risk, as most cash heavy portfolios have greatly underperformed the benchmarks over the past six months. The cash well still runs deep, and this could provide an added boost to the market in the coming weeks. Furthermore, with continued quantitative easing and economic growth on the horizon, there is sure to be growing concern over inflation. This fear over inflation will likely drive many to diversify out of cash and into inflation hedges like precious metals and basic materials.

However, we would have to caution against reading too much into these figures. In our experience, chasing performance can be disastrous for a portfolio because you may end up buying at a peak, instead at more attractive prices. We would have to think that at least some money managers are starting to become more defensive in light of the S&P 500 being up nearly 60% since the bottom. The advisors that had been invested at the bottom would be wise to take some profits and allocate them to cash and other less risky investments.

The hordes of cash on the sidelines, which are far greater than historical norms, will likely draw down in the near future as investor sentiment is mostly bullish right now and inflation has not materialized as feared. It will be interesting to see how the interplay of inflation concerns, investment advisors bullishness/bearishness, and other factors play into this trend.

How Much Sidelined Money Remains?

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