The 'mountain of cash' on the sidelines

The Los Angeles Times' Money & Co. blog examines whether money sitting on the sidelines in money market funds will flow back into stock funds, helping to fuel an extended bull run.

The conventional wisdom, backed by historical research, says it will.

In a research report on Monday, Jack Ablin, chief investment officer at Harris Private Bank in Chicago, said that whenever money market assets have exceeded 25% of the capitalization of the Standard & Poor's 500 index, stocks have rallied over the following two years. That number currently is 43% after having peaked at 58% in mid-December.

But the conventional wisdom isn't altogether correct, argues MMF guru Peter Crane.

[M]uch of the cash flow into money funds over the past two years had little to do with the collapsing stock market, said Peter Crane, chief executive of research firm Crane Data.

Corporations, which account for two-thirds of money-fund assets, have built up funds for purposes ranging from emergency reserves to bankrolling mergers, and are unlikely to put that cash into stocks, Crane said.

That's a big reason why overall money-fund assets are down only 4% from their mid-January peak despite the torrid market rally since early March....

So-called retail money funds - those used by individual investors as opposed to institutional investors - have been losing assets at a faster clip this year. Retail fund assets are down 8.2% from their January peak.

But the build-up of cash in those funds in 2008 was due in part to dissatisfaction with fixed-income investments that went awry, such as exploding auction-rate securities and some surprisingly risky short-term bond funds, Crane said. So some of that money now may be heading back into other income-oriented investments - including corporate-bond funds, which have seen hefty inflows this year, and bank accounts - rather than into stocks

This is likely a case in which both side are correct. Quoting SEC info, Forbes notes that $4 trillion is sitting in money market funds. Surely, some of that money will flow into stock funds and some won't (and, as Peter Crane points out, not just because investors are skittish).

The market is made up of millions of players, each making decisions based on unique circumstances and available information. Speculating about what all those other people might do is less helpful than knowing what you're doing and why.

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Joseph Slife is a contributing author and editor for SMI. Visit www.soundmindinvesting.com to learn more.