Tuesday, August 25, 2009

Guest Post: The Fallacy of Cash on the Sidelines

Below is a guest post from a money manager from the Great White North, who maintains the blog: Gestalt. No, I had never heard of that word either. In conversations with him he tends to use 3 and 4 syllable words found mostly on the SAT test (if at all), but thankfully as he is an avid contributor to our comments section he uses more simple 1 and 2 syllable wording that us Americans can handle. Please note, Canadians also misspell "center", as do the British. They also like curling - please don't let those shortcomings bias you as an American reader.

In this piece "Gestalt" argues that the commonly tossed around "massive amounts of money on the sidelines" just waiting to come into the market is a fallacy. At least if you include the money from traditional places that used to support the stock market. But it's a new day and age in our subsidized economy / stock market. If instead you include the massive influx of money our Federal Reserve is pruning from it's money trees and pumping into the banks (up from $90B to $900B in 18 months) - than we are talking about a whole 'nother animal. Per some Bloomberg readings much of the money the Fed is handing to the banks (at 0 to 0.25% rates) is being turned around by the banks to buy US Treasuries. Do you see the shell game going on? Aside from the shell game portion this is basically a handout to the oligarchs - take from the people at 0 to 0.25% and invest at any Treasury over a 1 year note and make money. Magic. Another portion of this money is most certainly being used to speculate in the stock markets - many of our largest banks are now seeing a surge in "trading gains" the past 2 quarters, and I am not just talking about Goldman Sachs (GS) - check out Bank of America (BAC) or JPMorgan (JPM). It is good to be a financial oligarch - our feudal system is working like a charm.

Using that money the Fed is handing out to actually create loans? (chuckle) That is so old school... forget it. Why bother lending to high risk Americans when you can (a) buy "no risk" US Treasuries that certainly yield far more than 0 to 0.25% and get money for free and (b) speculate in the stock market with essentially free money.

Below are Gestalt's views....

Merrill Lynch posted the results of its most recent Survey of Fund Managers for August this morning. The survey covered 204 fund managers in 80 countries who control $554 billion in assets, and the data dispels the myth of excess cash on the sidelines.

Barry Ritholtz at ritholtz.com summarized the findings. Note that U.S. markets peaked in September 2007:

Cash balances plunge to 3.5%, lowest since July'07;

Highest equity allocation (34% from 7%) since Oct'07;

Bond allocation (-28% from -12%) lowest since April'07;

• Tech (28%) is the most favored sector everywhere.

Barry concluded, 'While I keep hearing about cash on the sidelines, the professionals seem to be "All In."'

As an addendum to the Merrill Lynch survey (full release linked below), please see the attached chart of US commercial paper and Money Market assets. The chart was originally posted by WallStreetExaminer.com using US Federal Reserve data. Annotations in red are my own.

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Conclusion: Investable Money Market fund assets are no higher than at the peak of markets in September 2007. Retail holdings of MM funds have now retraced to the levels of Sept 2007. The spike in Institutional MM assets from Sept 2007 is exactly equivalent to the drop in CP assets over the same time period, offering compelling evidence that companies have simply moved treasury working capital out of CP and into IMM funds. This is NOT parked investment capital, and is unlikely to find its way into stocks.

Investors appear to be exactly as fully invested as they were in September 2007, at the peak of the bull market. This dovetails nicely with the Merrill survey.

That said, the Primary Dealers are swimming in reserves. Liquidity parked in Securities Open Market Accounts at Primary Dealers is also back at September 2007 levels (See PD Liquidity Chart). If the money-centre banks decided to leverage these reserves into the system, they could single-handedly push stocks, commodities and corporate bonds higher. It remains to be seen whether banks will hold these as reserves against 'Level III' assets on their balance sheets or put it to work speculating.

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Original Press Release

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