Notice that I’m asking When?and not If?
This rally looks like it has enough momentum to get through the 1,000 barrier. It sure helps that the big alternative to stocks, money market funds, are paying just 0.5% right now. With lots of cash on the sidelines I do think we’ll get through this level even if it might take a while. The Standard & Poor’s 500 stock index closed at 980 on July 28.
Why is 1,000 so important as a barrier?
First, although we investors may pretend that we’re rational to the core, the truth is that we’re as much followers of omens as the residents of medieval Europe who thought the world had to end in the year 1000. The market always struggles with these big round numbers just because in some of our bones we believe that “Hey, it’s got to stop here.”
Second, the 1,000 level marks a 38% recovery of the entire bear market drop from its October 2007 peak to its (current) March 2009 bottom. Tracking stocks with the commonly used RSI(relative strength index) shows that the market is now overbought for the first time since the rally started in March. In addition a move to 1,000 on the S&P would be a 50% gain from the March bottom.
Any technical analyst or stock market historian worth his or her salt knows that rallies tend to fail at these numbers. A 50% gain, for example, is the historical average for cyclical bull market rallies, according to John Murphy, one of my favorite technical analysts.
Even if you think technical analysis is just mumbo-jumbo and that stock market history is powerless to affect the present, the mere fact that so many investors follow these indicators gives them power over the market. Even if it is just the power of self-fulfilling prophecy.
So I wouldn’t be surprised to see stocks struggle here. It’s one reason that while I’ve bought a bit lately, I’m still happy to be sitting on 38% cash in my Jubak’s Picks portfolio. Nothing like buying on the dip.
But as I wrote on the first day of this blog, July 15, the amount of money on the sidelines is likely to limit any retreat. There are simply too many investors who missed out on the rally who will want in on the first drop.
I’d put professional money managers among that band. You might even say they’r leading the parade.
Getting killed in a bear when everyone else is getting killed is something their clients may be willing to forgive. Missing out on a rally–after getting killed in the bear market–would be, many managers fear, the last straw. Clients will move their money if at the end of their fiscal year they lag the rally by too much.
For a lot of money managers that fiscal year ends not in December but in October.
Think they’d like to get in before the clock runs out?
@Sigli
First of all, at the end of your simple example above “Jim uses his new $10 to buy $10 worth of ZYX shares”, yet you fail to mention from whom he bought these shares. Unless, the ZYX company was an IPO or they issued secondary stock, Jim purchased the shares from another participant in this secondary market, let’s call her Sheila, who is now on the sidelines with her $10 (provided she doesn’t withdraw the funds as currency and lights it on fire).
Second, when people talk about “cash on the sidelines” they are talking about money market funds (MMF), as Mr. Jubak mentions above are only earning 0.5% currently. MMFs always have a $1 per share price (with the rare exception), so there is virtually no instance where someone wanting to sell shares will get anything but $1 for each share she sells. It is the equivalent of cash. $1 = $1.
Third, if cash somehow magically transformed into stock with each secondary market transaction, then whenever the stock market went up, this would put serious downward pressure on the the money supply, specifically M2 and M3 which include MMFs.
Lastly, there is nothing to indicate that funds in MMFs are destined for the stock market, especially in this economy where people are seeing their neighbor’s houses being foreclosed, their co-workers being laid off, and their nest eggs decimated, not to mention baby boomers moving what’s left of their retirement into safer fixed-income investments.
Here are some good articles which describe the fallacy of cash on the sidelines in more depth:
http://www.hedgefolios.com/read/all-that-cash-on-the-sidelines
http://globaleconomicanalysis.blogspot.com/2008/11/sideline-cash-theory-revisited.html
http://www.zerohedge.com/article/money-sidelines-fallacy
P.S. I remember hearing the cash on the sidelines argument during the rally after the Bear Stearns bottom and we know how that piece of investment advice turned out.
To add, I think Hussman is probably right. However, I think his equilibrium needs a time element. It may take a few weeks or maybe even years before treasury yields are sufficiently high enough to entice the equalizing money back out of stocks (where it had been self feeding higher and higher prices). I think mean reversion would explain it slightly better than Hussman’s absolute equilibrium. But Hussman probably realizes the question is a little more complex than as he explained.
I’m a big Hussman fan and read his weekly commentary religiously. To be frank, however, he states this argument like it is the absolute gospel truth, and I think the subject deserves a bit more than a nice little story. With that said, I’ll add my own equally simple story to show a scenario that is equally true:
Jim has 10 shares of XYZ stock worth $1 a piece. TradeKing has $10 in t-bills. Sigli has $10 in cash in a bank c.d. Tradeking wants to buy $10 in XYZ, so he sells his t-bills. However, there aren’t many buyers for t-bills that day. Sigli buys Tradeking’s t-bills for $9, and spends his last $1 in cash to buy 1 share of XYZ stock from Jim. There is demand this day for XYZ stock, so Jim sells 8 of his 9 remaining shares to Tradeking for $9. Jim uses his new $10 to buy $10 worth of ZYX shares. At the end of the day, $1 came out of t-bills, $10 came out of cash, and $10 went “from the sidelines” into the stock market.
I don’t think this puzzle is anywhere near concluded. The data from TrimTabs seems to disprove Hussman. After all is said and argued, supply and demand reigns king. “Money on the sidelines”, may as well mean more potential buying demand for stocks. Same thing.
Hussman needs to give a real explanation with data, as opposed to his biblical prophesy of absolute truth.
@jbahr
Here a good quote from Dr. Hussman that sums it up:
Balances in money market funds are also not “cash on the sidelines.” Securities are simply evidence that money has been intermediated from a saver to a borrower. Once the security is issued, it exists until it matures or is otherwise retired. If I have $1000 “on the sidelines” in Treasury bills, it represents money that has already been spent by the Federal government. If I sell this T-bill to buy stocks, somebody else has to buy it, and there will be exactly the same amount of money “on the sidelines” after I buy my stocks than before I bought them. It is simply a fallacy of non-equilibrium thinking to imagine that money “goes into” or “comes out of” secondary markets in securities.
(http://www.hussmanfunds.com/wmc/wmc080414.htm)
Jim,
My argument did not include price. Prices rise and fall based on supply/demand. I get that. My argument (and Dr. Hussman’s – http://www.hussman.net/wmc/wmc060710.htm) is that there is always a lot of cash on the sidelines (especially with the money printing going on). Otherwise you would hear the argument at market tops that one should sell because there is a lack of cash on the sidelines. There never is.
“that seller doesn’t stay in cash but buys shares with his or her cash”
And, s/he buys those shares from someone else who is now in cash and no longer owns those shares.
Maybe, the issue is just a semantic one. If by “a lot of cash on the sidelines” you mean long-term investors are underexposed to stocks and overexposed to cash, then I agree with that. To put it another way, it’s kind of like saying the homeownership rate in the U.S. is 68%. It’s actually 100% because all homes have an owner. The 68% is meant to represent primary residences.
To continue, one of the falacies of your argument, TradeKing, is that you say that if I buy shares, the seller takes the cash and is now on the sidelines. So the net effect is zero. In a market with rising demand for stocks, however, that seller doesn’t stay in cash but buys shares with his or her cash and is willing to pay a higher price for the shares in that new buy.
I’d have to say I disagree Tradeking because the important point isn’t how many pieces of paper exist but what people are willing to pay for them. If the holders of one kind of asset–let’s say money in a money market account–decide that stocks are more valuable, they’ll pay more for stocks. The transaction doesn’t change the number of shares in circulation–if it did prices wouldn’t go up–but it does change the price of those shares on the market. In the system you describe, it seems to me that prices wouldn’t move since all we’re doing is shuffling assets among classes. My point is that this shuffling may not create any “real” wealth in the long-term but it sure does more prices in the present.
It’s three trading days between when I post a buy or a sell here and when I buy or sell for my personal account. The idea is to give readers a guarantee that I won’t try to make profits for myself by gaming the timing of these posts–for example by selling before I post a sell.
@jbahr
Because it is a secondary market. When you buy stock using cash, there is someone on the other end of the transaction selling you his/her/its stock for cash. So, now the seller is on the sidelines. This is why we call it trading. This is why the NASDAQ, et all. are called “exchanges”.
“In other words, why can’t there be a net increase in the number of all stocks held?”
Because there is a fixed supply of shares outstanding and each share *always* has an owner. They don’t just magically appear out of thin air, unless, of course their is an IPO or secondary.
I’m not sure I understand, TradeKing. What if everybody moves cash from their trading account’s money market fund to stocks? Doesn’t this just drive down money market rates? What makes you think that it nets out? In other words, why can’t there be a net increase in the number of all stocks held, and a net decrease in money market funds?
Again with the sideline cash argument! Jeez!
http://www.hussman.net/wmc/wmc060710.htm
“If Ricky sells his money market shares and buys stocks, then his money market fund has to sell commercial paper to Nicky, whose currency goes to Ricky, who uses it to pay for the stock bought from Mickey. In the end, the currency that Nicky held is now held by Mickey, the commercial paper held by Ricky is now held by Nicky, and the stock held by Mickey is now held by Ricky, and there is exactly as much stock, commercial paper, and currency outstanding as there was before. All that happened is that the owner of each security has changed.”
Thanks terryw. If buying a stock, I usually ponder it longer than a few days and often times lose the urge to buy. But it is a good feeling when buying one that seems right.
I think its just a way of Jim avoiding the “Jubak effect” (if there is one) where speculators might take advantage of his recommendations and cause temporary non market related movements on a stock. It dosn’t really matter if its 3 days or 3 business days. The horizon for his picks are 12-18 months, therefore 3 days shouldn’t matter. I find waiting for a few days sometimes sees the stock price fall and I get a better deal.
dermp1 on 26 July 2009
Jim:
I always wondered what your buying 3 days after the post meant. Is it 3 days or 3 business days. If you post on Tuesday do you buy on Friday and if you post on Friday do you buy on Monday? Just want to know though it doesn’t really affect what and when I do it.
It really is good to see your new site, an improvement when compared to MSN. Thanks for the suggestions, a great place to start and sometimes end.