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The Myth of "Cash on the Sidelines"

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Andrew R. Michaud

• January 11, 2024

Joseph Kalish, the chief global macro strategist at Ned Davis Research, challenges the notion that the massive $6 trillion in money-market funds can single-handedly lift the stock market. In fact, Kalish labels this argument as nothing more than "propaganda," particularly when considering the historical data of the money-market industry spanning four decades.

As Kalish points out in a recent client note, it is crucial to scrutinize the record. And upon doing so, the NDR team unearthed three significant declines in money-market fund data over the past forty years. The most substantial drop occurred twelve years ago, in the aftermath of the global financial crisis, where assets plummeted by 35.4%, equivalent to a staggering $1.4 trillion.

Additionally, notable declines were observed following the bursting of the technology stock bubble in the early 2000s, resulting in a 22.2% drop. Furthermore, amidst the ongoing pandemic in 2020, money-market assets experienced a 10.5% decrease.

What's interesting to note is that all three instances of decline coincided with Federal Reserve interventions to stimulate the economy by implementing loose monetary policies, thereby compelling investors to divert funds from cash into higher-yielding assets.

Contrary to common belief, money-market funds have actually accumulated around $1.4 trillion over the past year, based on data from NDR.

Conclusion

The prevailing narrative that "cash on the sidelines" can significantly impact the stock market is debunked by Joseph Kalish's analysis. Drawing from decades of historical data, it is evident that previous declines in money-market assets were closely tied to Federal Reserve actions and investors seeking higher returns. Therefore, we should approach the notion of cash reserves driving market movements with caution.

Record Highs and Declining Cash Reserves

In recent times, there has been a decline in money-market assets following significant bear-market movements in the stock market. This decline prompted investors to shift their focus from cash to equities.

However, the current situation is quite different. Money-market funds are generating returns of 5% or more, which is an attractive proposition for investors. Meanwhile, equities are trading near their all-time highs.

The S&P 500 index briefly traded above its previous closing record, achieved approximately two years ago. Likewise, the Dow Jones Industrial Average also experienced a series of record closes after substantial gains in the fourth quarter.

This remarkable performance can be attributed to a resilient economy and a sharp decrease in the 10-year Treasury yield in the final months of 2023. The decline in the benchmark interest rate, which serves as the bedrock of the U.S. economy, has provided borrowers with some relief. After briefly surpassing 5% in October, it has now settled around 4%, allowing for easier debt raising and refinancing.

Despite this positive outlook, there are concerns regarding the amount of cash available for investment. According to Kalish, although there are reasons to be bullish on equities and credit, the current cash reserves are not particularly robust.

Leadership should carefully assess their capital allocation strategies in light of these circumstances.

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