Money market bulge
Big cash balance won’t flow into stocks
I can’t tell you how many times I’ve read or heard the following reasoning
for bullishness: “There are record levels of cash sitting on the sidelines. The
inevitability of some of that flowing into equity markets will create a
significant demand for stocks – thereby pushing up prices.” It has intuitive
appeal but there are good reasons why I don’t buy it.
Common uses of money funds
I don’t know of any official stats on the most common uses of money market
funds, but there are three basic uses that I’ve identified in my decade of
industry experience. The first is for saving for large expenditures. This is
usually done over a period spanning more than one year. Another is to keep a
temporary cash reserve which is already earmarked for some predetermined purpose
(i.e. business opportunity). Finally, many investors do use money market funds
as a springboard into other types of funds, or as a temporary parking spot while
investment decisions are finalized.
There are surely other uses, but the key is to recognize that money market
funds are used in a variety of ways. Only one of those is a doorway into other
investments, and stocks are just one type of investment into which such funds
Reasons for rising MMF assets
There are two scenarios that can push money market fund assets to
historically high levels.
- Weak returns of long-term funds (i.e. non money market) relative to that
of money market funds will – all else being equal – decrease long term assets
while pushing up money market assets.
- Another scenario is simply stronger net sales (or smaller net redemptions)
for money market funds will result in a rising relative asset base in favour
of money market funds – again all else being equal.
Studying the last ten years of money market fund assets and net sales –
relative to long-term funds – simply reveals no meaningful relationship. The two
noticeable bottoms in money market assets (as a percentage of total IFIC assets)
occurred in April 1998 (after which the summer 1998 meltdown followed) and
September 2000 (near the peak of the share price of then index-heavyweight
Past trough levels fell between 10 and 20 percent of total fund assets, while
past peak asset levels tend to be north of 30 percent of total assets. However,
there are a couple of points worth making about these stats.
First, if these figures can be used for anything, it is to measure investor
sentiment not potential for demand for stocks. Sure, there may be a casual
observable trend between cash levels and subsequent stock returns, but the
available statistics are not nearly robust enough to draw any meaningful
conclusions. Plus, it’s only clear in hindsight – which is rather useless.
For what it’s worth, the current level of money market assets relative to
total fund assets is planted just a sliver above the median average over the
past ten years. So, even if you subscribe to this method, it would be rather
All of the above arguments notwithstanding, why would cash find its way into
the stock market if the fundamentals of such market are not attractive? In other
words, my point is that the fundamentals (both in absolute and relative terms)
must be sound to the extent that attractive risk/reward potential exists, before
a boatload of cash found its way into such securities. Plus, investors can
change their minds and instead decide that the money is better spent paying down
the record consumer debt levels seen in North America – which is never a bad way
to lock in guaranteed after-tax returns.
In and of itself, high levels of money market funds and other cash vehicles
is not necessarily related to eventual flows of funds into equity markets.
Dan Hallett, CFA, CFP is the President of Dan Hallett and Associates Inc., an independent investment research firm based in Windsor, Ontario. Dan can be reached at email@example.com.