Recently I saw a statistic that grabbed my attention. According to Ned Davis Research, money market assets (plus cash held by stock and bond mutual funds/ETFs) were just 20% of total fund/ETF assets. That compares to 22.3% at the stock market peak in 2007 and 24.8% at the peak in 2000.
Even more interesting to me was the statistic that money market assets represented more than 80% of total fund assets in 1982, and over the past 30 years, money market assets have averaged more than 38%.
Not only do the current record low cash holdings fly in the face of all of the “there’s lots of cash on the sidelines” memes, but they suggest that if the equity markets are to move significantly higher, that move must come from the funds rotating out of bonds and into stocks.
With bond assets currently at almost 26% of total fund holdings, versus a thirty-year average of 19.5%, clearly that rotation is a possibility. With the market anticipating higher rates ahead, and bondholders taking significant losses over the past quarter, investors could exit fixed income. But there are two aspects of that exit that worry me.
First, economic confidence, at least as measured by Gallup, is still negative (-7 this morning). The notion that investors would exit bonds and rotate into what are perceived to be more risky stocks doesn’t seem likely to me at current confidence levels, particularly as we are seeing record flows in balanced funds – which I’d offer ties closely to current social mood levels. From my perspective, for there to be a 1994-like rotation out of bonds into stocks, there would have to be a significantly higher level of confidence.
But there is a second and more worrisome aspect espoused by the Great Rotationists, and that is the fixed income market's ability to handle a major shift in asset allocation. Watching the bond market over the past quarter, it has been very clear at times that the market is having a very difficult time matching the rising exits from high-yield ETFs with the sale of the ETF’s underlying bonds. Bond ETFs are liquid; their holdings aren’t.
Should we start to see a more significant rise in rates, this liquidity mismatch is likely to exacerbate bond fund losses; in that scenario, it is hard to see how retail investors who sought ought bonds for their supposed safety in the first place would then turn around and buy stocks.
To me, the more likely scenario is the one where bond fund investors opt out altogether.
Admittedly, in the interim, we could see cash allocations decline even further, but at 20% already, I am not sure there is much more to be pulled out and deployed.
With both bond and stock funds overallocated versus their long-term averages, I can’t help but wonder whether the most likely scenario is one in which stocks and
bonds move to an underallocated position with cash holdings rising significantly.
Needless to say, this kind of an environment would seriously challenge most investors' thinking around asset allocation.
And one final thought in that regard: Speaking with bond investors today about cash as an investment alternative seems to immediately garner laughter. Cash yields zero, and people buy bonds for income.
In their current quest for income, what few fixed income investors seem to be willing to consider is thinking that frames the issue differently and suggests that cash yields 2% less than US Treasuries. The give-up in yield has never been less.
Thanks to the Fed’s zero interest policy, allocations to cash have never been lower, and yet from a relative value perspective, you could argue that cash may be the most undervalued asset out there.
Peter Atwater's groundbreaking book "Moods and Markets" is now available on Amazon and Barnes & Noble.
“Peter Atwater brilliantly provides a framework for understanding both the socioeconomic hubris that led to the great credit bubble of the past decade and the dark social-psychological hangover that has resulted from its collapse. In so doing, he offers an invaluable guide to what promises to be a very difficult and turbulent period ahead as we experience what he calls the ‘me, here, and now’ behavioral tendencies of the post-crash world.” —Sherle R. Schwenninger, Director, Economic Growth Program, New America Foundation
Author holds position in SH.
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