$6 trillion cash hoard may boost US stock gains with Fed’s pivot
December 14, 2023 – 10:04 PM PST
NEW YORK (Reuters) – Investors wondering whether markets can continue their torrid rally are eyeing one important factor that could boost assets: a nearly $6 trillion pile of cash on the sidelines.
Soaring yields have pulled cash into money markets and other short-term instruments, as many investors chose to collect income in the ultra-safe vehicles while they awaited the outcome of the Federal Reserve’s battle against surging inflation. Total money market fund assets hit a record $5.9 trillion on Dec. 6, according to data from the Investment Company Institute.
The Fed’s unexpected dovish pivot on Wednesday may have upended that calculus: If borrowing costs fall in 2024, yields will likely drop alongside them. That could push some investors to deploy cash into stocks and other risky investments, while others rush to lock in yields in longer-term bonds.
Cash has returned an average of 4.5% in the year following the last rate hike of a cycle by the Fed, while U.S. equities have jumped 24.3% and investment grade debt by 13.6%, according to BlackRock data going back to 1995.
“We are getting calls … from clients who have a significant level of cash and are realizing they need to do something with it,” said Charles Lemonides, portfolio manager of hedge fund ValueWorks LLC. “This is the beginning of a cycle that will start to feed on itself.”
Recent market action shows the scramble to recalibrate portfolios may have already kicked off. Benchmark 10-year Treasury yields, which move inversely to bond prices, have fallen around 24 basis points since Wednesday’s Fed meeting to 3.9153%, the lowest since late July.
The S&P 500 is up 1.6% since Wednesday’s Fed decision and stands less than 2% below a record high. The index is up nearly 23% this year.
“If you think the Fed is done with the hiking cycle, then it’s time to deploy cash as the opportunity is there,” said Flavio Carpenzano, fixed-income investment director at Capital Group.
Not all the cash in money market funds may be available as “dry powder” to be invested in stocks and bonds. Some of it is held by institutions that might otherwise have that money in bank deposits and is needed for cash purposes, said Peter Crane, president of Crane Data, which tracks money market funds.
History also shows that the bulk of cash in money markets tends to remain even as rates come down, said Adam Turnquist, chief technical strategist for LPL Financial.
“I think you could start to see some flows come out of money markets and chase this rally, but I don’t think we are going to see anything to the tune of a trillion dollars or some massive flows that some people might expect,” Turnquist said.
And while money market assets are at record highs, their size relative to the S&P 500 is smaller than it has been during past peaks.
Total money market fund assets as a percentage of market capitalization stand at about 15.5%, in line with the long-term median and well below the record high of 64% hit in 2009 in the aftermath of the global financial crisis.
For now, however, investors’ appetite for risk has been easy to spot. In the options market, for example, traders are spurning protection from a near-term drop in stocks even though the price of such hedges is attractive from a historical standpoint. The Cboe Volatility Index (.VIX), which reflects demand for insurance against market swings, fell to pre-pandemic lows this month.
“No one is interested in buying insurance,” said Chris Murphy, co-head of derivative strategy at Susquehanna Financial Group, noting that the low level of defensive positioning leaves the market vulnerable to a sharp reversal in the event of an unforeseen negative shock.
Indeed, the sharp rebound in equities from their October lows has made some investors wary that markets have risen too quickly.
“There’s enough money out there that it doesn’t take a lot to directionally move the markets higher,” said Jason Draho, head of asset allocation, Americas, at UBS Global Wealth Management.
Still, the swift gains over the past six weeks in both equities and stocks “makes you a little concerned about where the upside is from here for the markets overall,” he said.
Reporting by David Randall, Saqib Iqbal Ahmed and Lewis Krauskopf; Additional reporting by Dhara Ranasinghe; Editing by Ira Iosebashvili and Leslie Adler
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How does the size of money market fund assets relative to the market and historical trends affect the likelihood of all the cash being invested
Investors are keeping a close eye on a significant factor that could potentially boost market assets - a nearly $6 trillion pile of cash on the sidelines. The recent surge in yields has led to an influx of cash into money markets and other short-term instruments as investors sought income in safe vehicles while awaiting the outcome of the Federal Reserve’s battle against inflation. According to data from the Investment Company Institute, total money market fund assets reached a record $5.9 trillion on December 6.
However, the Fed’s unexpected dovish pivot may change the equation. If borrowing costs fall in 2024, yields will likely drop as well. This could prompt some investors to deploy their cash into stocks and other risky investments, while others may choose to lock in yields by investing in longer-term bonds.
Historical data suggests that cash has returned an average of 4.5% in the year following the last rate hike by the Fed, while US equities have seen considerable gains. This has led many investors with a significant level of cash to realize that they need to do something with it. Charles Lemonides, a portfolio manager of hedge fund ValueWorks LLC, believes that this is just the beginning of a cycle that will continue to feed on itself.
Recent market action indicates that the scramble to recalibrate portfolios may have already started. Benchmark 10-year Treasury yields have fallen since the Fed meeting, reaching their lowest level since late July. The S&P 500 has also seen gains since the Fed’s decision. Flavio Carpenzano, a fixed-income investment director at Capital Group, suggests that if investors believe the Fed is done with the hiking cycle, it’s time to deploy their cash.
However, not all the cash in money market funds may be available for investment in stocks and bonds. Some of it is held by institutions that need it for cash purposes. Additionally, history shows that a significant portion of cash in money markets tends to remain even as rates come down.
Despite the record-high money market fund assets, their size relative to the S&P 500 is smaller than previous peaks. Currently standing at about 15.5% of market capitalization, it is in line with the long-term median and well below the record high of 64% in 2009 after the global financial crisis.
The appetite for risk among investors is clearly evident. Traders in the options market, for instance, are showing little interest in buying protection against a near-term drop in stocks, even though the price of such hedges is historically attractive. This leaves the market vulnerable to a sharp reversal in the event of an unforeseen negative shock.
Despite the market’s swift gains in recent weeks, some investors are cautious about the sustainability of the rally. The rapid rise in both equities and stocks has raised concerns about the upside potential for the markets. With enough money in the market to directionally move it higher, investors are becoming concerned about the overall market outlook.
In conclusion, the massive amount of cash on the sidelines has the potential to significantly impact market assets. While the recent dovish pivot by the Fed may encourage investors to deploy their cash, historical trends and the size of money market fund assets relative to the market suggest that not all the cash will be invested. The market’s appetite for risk and concerns about sustainability also play a role in shaping the future direction of investments.
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