Why Trillions of Dollars on the Sidelines Maybe A Good Thing
by Alexander Green, Oxford Club Investment Director
Thursday, February 5, 2009: Issue #929
You can’t blame most market investors for being nervous…
- The stock market has done a belly flop.
- Real estate keeps tumbling.
- The economy remains weak.
- Jobless claims recently hit a 26-year high.
Investors have pulled tens of billions of dollars out of stocks and plunked it in the bank.
We are optimistic, nonetheless. Why? Because the bad news is already reflected in current stock prices.
Valuations are attractive. Negative sentiment is a bullish signal, not a bearish one. And all that cash sitting on the sidelines is actually a good thing.
This month we’ll look at why.
We’ll also highlight a world-class biotech firm that will allow you to take advantage of one of the most attractive buying opportunities in almost two decades.
The Worst Year For The Stock Market
Last year was the worst year for the stock market since 1931.
In the second half, investors yanked tens of billions of dollars out of equity mutual funds and squirreled them away in cash accounts paying 1% – or less.
Some analysts see this as a big negative. It’s not.
Today there is more money available to buy shares than at any time in almost two decades. The $8.85 trillion held in cash, bank deposits and money market funds is equal to 74% of the market value of U.S. companies, the highest ratio since 1990, according to the Federal Reserve.
What has happened in the past when cash reached these levels?
- In September 1974, cash on hand reached $604.5 billion, representing a record 1.21 times the U.S. stock market’s capitalization. That preceded a 31% gain in equities between October 1974 and March 1975.
- In July 1982, just as a 20-month bear market was ending, cash as a percentage of the U.S. stock market’s value rose to 95%. The S&P 500 began a six-month, 36% advance.
According to Bloomberg, the eight previous times that cash peaked compared with the market’s capitalization, the S&P 500 rose an average 24% in six months.
There are no guarantees, but this is a very positive near-term signal for the market.
Understanding the Significance of High Cash Levels
Smart investors – even bearish ones – understand the significance of high cash levels. For example, Leuthold Group, whose Grizzly Short Fund returned 83% in 2008 thanks to bets against equities, recently put out a bulletin calling stocks “one of the great buying opportunities of your lifetime.”
The report pointed out that the ratio of cash on hand to U.S. market capitalization jumped 86% in the first 11 months of last year. That’s the biggest increase since the Fed began keeping records in 1959.
In other words, the powder is there. All we need is a match – and stocks could blast much higher.
And it probably won’t take long. After all, cash is earning a negative real return right now. Investors will get itchy eventually. And when they do, that money will return to the market.
Investor psychology was badly scarred over the past 15 months, however. So I believe the early money streaming back will seek a home in big, safe, blue-chip stocks.
Good investing,
Alex
Today’s Investment U Crib Sheet
As part of our continued improvements at Investment U, we’ve been providing our expert stock insight through our “Stock of the Day” Here are some of this week’s hot stocks.
In addition, if you haven’t already, take a look at our daily IU Blackboard. Here are the last three:
Louis Basenese looked at General Electric earlier last week. In fact, if you’re an income investor in GE you might want to read why “GE Is A Dog at Any Price.” He explains why, and what you can do about it.
Related Investment U Articles:
- What the VIX Is Indicating You Should Do Right Now
- The Dividend Stock Recovery: Get Ready for a High-Yield Bonanza
- Buying Stocks: Don’t Succumb to The Siren Song of the Naysayers
- High-Yield Bonds Are Shining Brighter Than Ever!
- Why Bad News Should Be Your Buy Signal
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Alexander Green is the Chief Investment Strategist of Investment U. A Wall Street veteran, he has more than 20 years of experience as a research analyst, investment advisor, financial writer and portfolio manager.
