It’s called fuel for the next rally. But it’s better first to think of the money piling up on the sidelines as water building pressure in a pipe.
In the week that ended on Wednesday July 7 more money flowed into money market funds—and out of other financial assets such as stocks than in any week since January 2009. (Do I need to remind you what happened in March 2009? The market bottomed and set off the second greatest relief rally in U.S. stock market history.
Money market funds took in $33.5 billion in the week, according to EPFR Global. The United States accounts for about two-thirds of the money market funds that EPFR tracks.
The week also saw about $420 million flow into commodity funds as traders sought the safety of gold and other precious metals.
The money in money market funds is earning 0.5% or less—in some cases much less.
That’s only an acceptable yield as long as fear stays high. And the longer that money sits on the sidelines the harder it is for money managers to accept that kind of yield, safety or no safety. So think of this stage of the market as analogous to water building up in a pipeline behind a cork. At some point the pressure becomes impossible to resist and the water breaks lose. Money flows into markets—any sort of market—in search of something better than a 0.5% yield.
Now under the right conditions that flood of cash under pressure ignites financial markets. (Think of it as a flood of gasoline if my mixed metaphors are making you crazy.) The flood of cash in search of better returns drives up prices, leading more cash to slow into the market, driving up prices some more.
The cash that had been on the sidelines becomes fuel for the next rally.
But it doesn’t have to work that way. The flood of cash may drive up prices for a brief while—but only long enough to meet a new flood of worries. The two waves meet and the cash flows wash back toward the sidelines as temporary gains turn into slight losses that raise fears that bigger losses are to come.
So yes, a buildup of cash on the sidelines is necessary for the start of another rally—and in that sense the data is cause for optimism. But the buildup of cash isn’t sufficient. By itself it’s not enough to create another rally. That will require an end—or at least a temporary resolution—to the worries about euro debt, the European banking system, growth in the U.S. economy, and growth in the Chinese economy.
We could see the tide of worry start to turn in late July with the European banking stress tests due on July 123—if they’re reassuring rather than worrying. Good macro economic data from the United States and China on second quarter GDP growth and positive trends in the U.S. employment market and in Chinese exports would be necessary next steps to turn the pressure into fuel.
And it might take markets until September or October to get comfortable in those areas.
I can’t help but think the typo “123” is about right, not for the stress test results, but for some of the fog to clear. July 123 would be out there somewhere around October or November. Until then? I think mostly just bumps and grinds.
Correction:
After reading Jim’sl atest this morning it occurred to me as if out the blue that I most certainly meant that S&P 1130- not 1030- would be a higher high and could constitute a buy signal…
But then, I said I’m not much on technical analysis. [Doubt anyone noticed, anyway- and everyone has now gone on to more current considerations.]
CPI also completely misses aggregate demand, which is the big picture. CPI way understated housing on the way up and has done the same for the inverse. Also, substitution purchases (for lower prices) and simply putting off purchasing (goods whose prices are rising) show up in CPI as inflation, when the opposite is true in the real world. These things all show up in AG as deflation. Sure GDP is up, but so is the population.
I would add that cash increases in value as the dollar rises versus the basket of currencies of its major trading partners (the “dollar index”).
Correct, EdMcGon, it’s decreasing inflation, typically as measured by the CPI which has been trending down since early ’08, and has even gone negative in a few of the more recent months. However, the CPI does NOT include housing, which if it did, would most assuredly be consistently negative.
I suspect it is housing (and commercial real estate) deflation that has Bernanke most concerned, particularly since home equity represents such a large portion of individual wealth, and as it contracts, so will spending.
javos,
I like that description: “dis-inflationary”. It’s not inflation, and it’s not deflation. We have some commodities going up and others down right now.
And don’t forget what deflation does to profit margins…it CRUSHES them! And “pop” goes the stock price, my friends.
Ya’ll be careful out there now, ya heah?
Further, Jim, I must strongly disagree that cash in MMF are earning “0.5% or less”. In our dis-inflationary economy (which may soon be a deflationary economy), cash has a very substantial return. Consider why people are not buying houses, or cars, or cruises. They see prices coming down. So, holding their cash is actually earning them something real.
Businesses are doing the same thing. They see the price for needed commodities (lumber, cement, aggregate, copper, steel, aluminum, computers, etc.) coming down. So why should they invest now when prices are coming down, and demand is soft anyway?
So your optimism should instead be pessimism. If this continues much longer, the world economy will tip into deflation, and cash will REALLY be worth something.
Mr Vann,
My view on the emerging markets is to enter them slowly. I have a small stake in CSKI at the moment, and I am looking for more extremely undervalued stocks with growth potential in those markets. I think now is a good time to increase positions (no more than 5-10% of your portfolio right now) in emerging markets, but do it VERY slowly.
cjxland, I like your “hoof in mouth” phrase. Been known to execute the same move myself.
From the perspective of a 69-year-old investor of more years than I care to recall, you folks certainly do seem to me to be in a hurry. With trillions of dollars sloshing around this planet, most of which exist merely as digital bytes and tied to nothing than can be described as real wealth, you can be assured NOTHING is going to happen very fast.
Like cjxland, I’m waiting for a pitch that I really like, a really fat one that I can pole outa the park, like what happened in March ’09. Til then, I’ll go climb some easy 14ers in Colorado with my wife and dog.
Mr. Vann
I’ll stick my hoof in mouth to get some conversation going on your issue:
I am not a technician, but I’ve learned from my betters to respect this practice…because an awful lot of others believe in it completely. So- if the Dow makes a new high above 10,500 [S&P above 1030 for the pros] that could signal a fine time to jump back in…or maybe you should just take the plunge now, ahead of the crowd? [Care for a bit of fear with that greed, or maybe the other way around?]
For my portfolio, I have been waiting for the Great Bear to return for some time now, and I can wait a lot longer; whether that represents pent up demand or money-off-the-table I leave to the pros- and history.
Jim, there is a not-so-subtle assumption in your words that cash coming in from low-yielding MMFs will go to the long side. Have you looked lately at the volume of cash trading on the short side. It’s become very easy lately to short, even leverage short, the major indexes and various sectors, like finance, energy, consumer, etc.
If that cash perceives an opportunity on the short side, that’s where an increasing amount of it will go.
Ed, I have not been seeing much conversation on China and emerging market stocks and ETFs that seem to stand out when the time seems right to start jumping in? Do you have thoughts you are ready to share on the subject? Anyone else? Would love to see some ideas shared and generated …
If corporate earnings during the next couple of weeks are decent, but 3rd-4th quarter guidance is cautious, then it’s difficult to see how the current trading range breaks out into a genuine rally. Some sideline cash might be committed when the market is perceived as “oversold,” but the current trend is to withdraw the cash just quickly, ie, “sell the rally.” It seems live investors won’t reverse this psychology until: 1) they discount the current soft patch and anticipate “real” growth, perhaps led by China, Brazil, etc., or 2) the Fed steps in with Q.E. II, or 3) a real sell off puts a bottom in this market (as a result of a double dip, European bank problems, etc)
Jim,
I don’t see that money entering the market in a flood. I expect it will be a very slow trickle, which will immediately turn off at the first sign of trouble, and possibly reverse if the trouble is bad enough.
to me this sounds a bit optimistic, which contradict with the last post on Friday.
He meant July 23.
I’ve been hearing for years how much money is on the sidelines earning nothing and people sooner or later will get the itch to deploy it to stocks. still waiting…
my 2 cents is short term I believe the earning news will be positive and we’ll have a summer rally which will mark the peaks for the year. Then the focus will be about the expiring Bush tax cuts and people will sell their winners to get the lower capital gains rate.
When is July 123?