Cash Becoming Less Attractive, For Most

Posted At 9:15 AM EST

Good morning...We begin the day with a surge in buying interest in the pre-market futures, after Friday's late surge left many scratching their heads and wondering about who had an agency heading into a new month.

At month-end, one of the more interesting pieces of data that gets released is the cash levels held by mutual funds.

We show this on the site as a percentage of total assets, and also expressed as a function of prevailing short-term interest rates.  After all, if 3-month Treasury Bills are offering 11%, then a fund manager would probably be more likely to park some funds in cash rather than risk them in stocks.

For the month ended in April, short-term rates declined, and so did cash levels, from 5.5% of total assets to 5.2%.  Combined with a roaring stock market, it's not a surprised that cash levels dipped.  Seasonality plays a part, too, as the chart below shows.

Cash levels tend to dip during the spring and summer months, especially heading into June.  It picks up a bit during the fall (likely due to stock market volatility), then crashes in December - perhaps as shareholders take year-end distributions and funds are left with less idle cash.  During the beginning of the year, funds get a load of new money, and the percentage of assets held in cash has risen 75% of the time during January.

While equity mutual funds don't necessarily hold their excess cash in money market funds, other investors most certainly do, and that's been a hot topic over the past few months.  We've often discussed the potential impact of cash sitting on the sidelines could have if it found its way back to stocks.

Who is holding all that cash could be important, too.  Generally, we should be more interested in retail (i.e. mom and pop) investors and less concerned about institutional funds.  Institutions have all kinds of reasons to move money in and out of money markets; mom and pop have many fewer reasons and their movements should be a better read on overall sentiment towards stocks.

The chart below shows how the money market landscape has changed over the years.  Prior to 2001, retail investors (the red line) dominated money market flows, making up more than 80% of total assets in these ultra-safe funds during the early 1980's.  That has steadily eroded, dropping below 50% in 2001 and less than 30% today.

Over the past few weeks, retail investors have pulled money out of money markets while institutions have continued to plow money in.  The only other time since 1980 that there was a similar scenario was from July 1991 through July 1992, which led to a choppy move higher in stocks.

Let's take a look at those figures as a percentage of the S&P 500's market cap.  We've done this in the past, now let's see just who could buy the index.

Clearly institutions are in the driver's seat here, especially over the past few years.  In March the big boys could have bought about 40% of the entire S&P; mom and pop could have only afforded about 16% of the index.

But it's still important to watch individual investors as a sentiment tell.  The chart below does just that, looking at total money market funds held by retail investors as a percentage of S&P market cap.

In March, the amount shot to a record, surpassing the previous high of just under 16% in August 1982.  The other peaks were 12% in December 1990 and 9% in November 2002.

Once retail investors began to put money back into stocks after stuffing it in money markets, the stock market tended to do quite well going forward, thank you very much.  Each instance coincided with the end of a bear market, consistent with what we looked at last week regarding the surge in consumer expectations versus their current situation.

Bottom line - Intermediate-term Outlook:  Neutral  (since April 9)

Beginning in early March, we discussed a large number of reasons to expect an imminent rally of one to three months' duration.  Some of those studies were even more positive, and suggested not just a rally, but possibly a new bull market.

During mid-April, several of our measures like the Indicator Score and Dumb Money Confidence reached levels that usually result in either a flattening out of the price rally, or an outright decline, especially during a bear market.

But the market held up extremely well in spite of some of these overbought types of indications.  This is very rare during an ongoing bear market, and is important to keep in mind especially given many of the "this time is different" kinds of studies we reiterated in early May.

The S&P 500 broke out over 875 a few weeks ago, and has since re-tested that breakout level twice, holding firmly both times.  This makes it exceptionally hard to find anything "wrong" with the rally so far.  Some preliminary uptrend lines were broken earlier this month, showing a slow-down in the trend, and there is a possibility of forming a double top if we break below 875ish (which would project down to about 830).  But unless that happens, trying to bet against this rally is a tough row to hoe.

On Friday we looked at how the market typically reacts coming out of an extremely tight multi-week range.  Usually it breaks lower first, but even more consistently the first move tends to be a "false" one, with an upside breakout leading to more weakness than strength after the initial surge.

Given that and a bevy of technical factors, I'll be looking for the current rally to run into more potential trouble should the S&P trade into 940-950 this week, especially if it would happen into the close today or early Tuesday.

Bottom line - Short-term Outlook:   Neutral  (since April 20)

There were a whole host of conspiracy theories bandied about over the weekend with regard to Friday's unusual trading.  Whispers suggested some large funds got caught flat-footed with huge short positions, others just knew it was Goldman Sachs making yet another self-serving round of trades, and still others suggested it was just bored day-traders looking to make a quick buck.

I don't spend any time on these things, there's rarely any way to know who or what or why made the trades that goosed the market in the final minutes of trading.  It's not like this hasn't happened before - there have been 9 times the S&P 500 surged 1% or more during the final half-hour, and gapped up 1% or more the next morning.

The last one was on March 26th, and the S&P managed to close another +1.6% higher from the open.  That was more common than not, as 7 of the 9 days closed higher after that large opening gap.  But none of them occurred at multi-month highs, either, like we're seeing today.

There have been 25 times the S&P 500 futures gapped up 1% or more to a new three-month or greater high.  Buying the open and holding until the next day's close resulted in only 7 winning trades and an average return of -0.4%, so chasing these gaps into new highs didn't often pay off by much.  If it happened on a Monday, the S&P closed lower by Tuesday 4 out of the 5 times.

Our shortest-term guides are mostly in neutral territory, and we do have some quite positive seasonality for the next day or two, so I'm not as enthused about trying to fade this gap as I would be if we were already extremely stretched short-term and heading into seasonal headwinds.

If we hold this gap and see higher intraday highs after the first hour, then I suspect still higher prices are in store going into the close.  If we happen to head into 940-950 and get some overbought readings by the close, then I'll probably be looking to short some especially if we gap up again Tuesday morning.

All the best,