The Cash Cushion

The Cash Cushion

Thursday, September 4, 2008

Every day, news headlines blare about the "credit crunch". We get battered with stories about how it is crippling businesses, hedge funds and even Joe Unlucky trying to buy a house.

One thing that seems to be under-reported is the "cash cushion", the flip side to the credit crunch. While lenders tighten their lending standards and some business are starved for credit, investors have been busy stuffing cash under their mattresses.

According to the latest survey from the American Association of Individual Investors (AAII), their members have dramatically altered the way they allocate money among stocks, bonds and cash.

Stocks now make up only 53% of their portfolios, down from 58% last month and nearly 70% in mid-2007. The current figure is one of the lowest amounts in more than a decade, other than from August 2002 through May 2003 and November 2005.

Investors haven't moved into bonds, however, which remained steady at 15% of their portfolios (which is still quite high historically). Instead, they went from cash taking up 27% of their portfolio to 32%, one of the highest amounts in years.

One problem with the data is that it is only a survey - AAII is counting on people telling them what they're doing with their money. They could be saying they have 32% of their money in cash, but in reality it's more like 5%. I'm not sure why, but sometimes people lie.

So let's look at hard numbers. The following chart shows the amount of money sitting in money market funds in the U.S., expressed as a percentage of the market capitalization of the S&P 500:

This is a pretty compelling chart. As of July 31st, there was enough money sitting in one of the most liquid investments available to buy slightly more than 27% of the entire S&P 500. Imagine what a company's stock would do if they suddenly announced that they were going to take more than a quarter of their float off the market.

Two caveats with this data: 1) Assets have been high for several months, and it has not prevented the stock market from falling, and 2) High cash positions aren't bullish in and of themselves - they only become bullish once investors begin to allocate that money back to stocks.

Let's take one more look at the potential buying power out there, this time from our NYSE Available Cash indicator. We've discussed this indicator several times over the years, and it's very simple - we're just looking at the cash left over in brokerage accounts after we subtract all the debt that investors owe from the cash they have sitting in their accounts. This does not include proceeds from short sales, which are restricted and not available for withdrawal.

The latest release from the NYSE showed yet another spike higher in the figure, to $156 billion. Other than recently, the only other time this figure was so positive was in the late 1940's and in 2002.

Almost every day, there is a new article in the popular finance magazines and websites expressing the need to live more frugally now that the economy is in so much trouble. That's a good thing - we in the U.S. have spent way too much for way too long, and it's beyond time to pay the piper.

Normally the pleas for living within our means falls on deaf ears, but it really does seem to be taking hold of late. Various figures have showed an improvement in savings ratios and debt reduction. The pullback in spending will hurt companies trying to sell products, obviously, and that may overpower the potential positive we're seeing by large cash balances.

But historically at least, when we've seen cash levels as high as they are now, some of that money has found its way back to the stock market. It may not result in higher prices next week or next month, but longer-term what we've seen is market-positive.