The drumbeat of negative news just continues to sound louder, from a loss at AIG that was 37 times larger than estimates (!), to a cacophony of calls that the Oracle of Omaha has once again lost his "magical" touch, to the first cut in dividends at GE since oil was discovered in Saudi Arabia (1938).

We've often looked at the impact this is having on investors, in terms of moving money out of stocks and into cash.  That hasn't stopped in the least.

The latest monthly figures for the mutual fund industry were released on Friday, and they showed that mutual fund managers were doing what everyone else was scrambling to do, too - raise as much cash as humanly possible.

These folks have been increasingly subject to a tough charter of not timing the market, no matter how bearish they may be.  That's part of the reason we haven't seen the big spikes higher in liquid assets at mutual funds, but another is the record low interest rates paid on cash.  There isn't as much incentive to hold a super-liquid investment when it's yielding 0.1% as when it's yielding 10% like we saw in the 1980's.

Even while yields trudge along near all-time lows, however, we're still seeing fund managers allocate more of their portfolios to cash, which made up 5.8% of their total assets in January, from 5.2% in December.

When we factor in interest rates, we can try to figure out a baseline amount of cash that funds should hold in order to meet redemptions, etc.  This is the premise behind the Mutual Fund Cash Surplus / Deficit indicator, shown below.

Currently the indicator has moved up to 1.1%, basically meaning that funds are holding 1.1% more cash than they "should" given their historical need to meet redemptions, and the yield they are receiving on cash investments.

While this is still below the +2% level that has marked some prior extremes, it's obviously much-improved from the -3% we saw in the spring and summer of 2007 (and the spring of 2000 prior to that...).

This +1.1% figure is the highest since 1995.  If we go back to the 1950's and look for anytime the Surplus / Deficit climbed above +1.1% from below, then three months later the S&P was up 78% of the time, averaging +5.7%.

It's not really appropriate for that short of a signal, so looking at one-year returns, the index was up 16 out of the 18 instances, averaging +17.0%.  Most importantly, the average risk one had to endure (-7.5%) was swamped by the average reward that was offered during the year (+24.5%).

Looking at two-year returns, the S&P was 18 for 18, averaging a gain of +25.7%, with a risk not much worse than the one-year (-9.0%) and a maximum return that jumped quite a bit (+36.2%).

It isn't just fund managers raising cash, it's a lot of folks.  Individual investors as well as hedge funds have been piling into money market mutual funds, and as of the end of January there was enough cash parked in those funds to buy up 47% of the entire S&P 500 index.

This amount is so far and above any other extreme in the past 25 years as to render it useless for timing purposes.  We've known for many months that the amount of assets hiding in safe investments is enormous, and exceeds levels that have historically indicated extreme fear, and an imminent return to risk-seeking behavior.

Lots of cash on the sidelines isn't bullish until it begins to return to the market, however, and as yet we're seeing few signs of that.

 Disclaimer  |  Privacy Policy