Cash on the Sidelines: A Positive Market Indicator?
A number of different financial institutions have recently completed surveys [including U.S. Trust Bank of America Private Wealth Management, referenced in the chart below] that show investors are hoarding cash, which a number of pundits are saying lends support to their forecasts for continued global market advances. The rationale behind these claims is that the markets will keep going up because there is so much cash on the sidelines that is ready to go into the market. Meanwhile, others are convinced we are at or near short-term highs for many indices, but only time will tell who was right. All we know right now is that there are numerous investors with quite a bit of money on the sidelines.
Already a rather lengthy rally, this has been a most unusual run up in equity markets. The Fed and other central banks around the world have gone to great lengths in order to prop up world equity markets. That being said, fund flows have only recently reversed course from negative to positive and this makes it seem increasingly likely that we are still a ways from the end of the current run. In addition, we have yet to see widespread optimism with regards to market prospects and certainly nothing on par with the euphoria that preceded the last two market bubbles.
Source: 2013 U.S. Trust Insights on Wealth and Worth (Based on responses to Q22a)
Every one of you has likely read or heard some ‘expert’ claim that markets are going to keep going up as long as there is cash on the sidelines. It sounds logical, right? Except that it isn’t. A stock exchange is known as such because it is just that, a medium of exchange. Namely, a buyer and seller exchange cash for shares or vice-versa. So, there are no huge sums of money about to ‘enter’ the market; it will be swapped so that the same amount of money is ‘in the market’ both before and after any transaction. Put another way, money actually moves through the markets.
Furthermore, let it be stated that there will always be some cash on the sidelines and that cash positions are widely viewed as a lagging indicator, when given any credence at all. Some of that cash is sitting in chequing accounts – earmarked for bills and expenses – not able to be invested regardless of market conditions or prospects. Bubbles typically coincide with periods of optimism or irrational exuberance. But, when the wealthiest amongst us are not invested, that is a pretty definitive indication that we are far from exuberant and presumably far from bubble territory or any subsequent marked correction in the markets. But, this is completely unrelated to cash levels.
At T.E. Wealth we tend to agree with the position that cash is not an actual investment option and nor is it something we view tactically. Rather, our clients hold cash in order to fund near-to-medium term cash flow needs, which helps reduce the probability of having to complete sales from other asset classes, especially important if the markets have been weak leading up to a withdrawal date. And, we assign no importance to the amount of cash that is or isn’t on the sidelines.
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