Archive for April, 2010
If you watch CNBC, you often hear commentators say that the small investor sits on the sidelines with oodles of cash in his money funds, and he is feeling left behind in this rally. Then you hear, either that this cash will fuel the next leg up, or, when the public gets in, that will be time to sell, because the little guy is always wrong.
And skeptical as I may be, the bulls are getting some support for this argument. According to the current Barron’s, money recently started flowing into equity mutual funds, about a year into the bull run. Not much, only about $11 billion over the last eight weeks, but the shift in direction might matter, especially with the Dow holding 11,000 today. Just to be clear, I’m not expressing an opinion on market direction here, only about the cash-on-sidelines theory itself.
First, as a matter of simple accounting (or arithmetic), there never was and never will be cash on the sidelines in the way many people discuss it. Think about this: if I buy stock with cash, the seller now has this cash. Is HE now holding cash on the “sidelines?” In any case, the cash still exists, the owner of it changed. Thereafter if the investor who sold the stock to me, buys other stocks with it, then a third party will have the cash. And so on.
Secondly, I’m not sure that the small investor’s target asset allocation is as heavily weighted toward stocks as it used to be. In other words, a smaller maximum percentage of investors’ money fund balances will go to stocks than in the past; more assets will be reserved for safety. In this video (h/t Barry Ritholtz) David Rosenberg states that for nearly all of this rally, cash had been not only standing pat, but flowing OUT of equities. One key reason is demographic. As we baby boomers get older, our risk tolerance naturally decreases. Our appetite for stocks goes down and our appetite for fixed income goes up, because we have a shorter time horizon, with less time to make up for losses than we did when we were younger. And so advisors who specialize in asset allocation (which is most of them, since the old fashioned brokers who knew something about stockpicking are long gone) just about have to tell many of their clients to re-balance, out of equities.
These facts rest against a well-known backdrop, that stocks have had two bad crashes in the last decade, and the SPX is trading about 200 points lower than it did ten years ago in April 2000. Buying and holding stock index funds has been a losing long-term strategy for most investors who are active now, but bonds have been in a VERY long bull market that dates from the early Eighties. In other words, stocks have burned you and bonds haven’t. The “easy” trade is to buy the asset that has treated you well for as long as you can remember. That’s Treasurys. (I didn’t say, buying T-bonds is the right trade, but we’ll get to that.)
Furthermore it would seem that institutions are already committed to stocks. In this chart it seems like the institutional investors – at least those who run mutual funds –don’t have much more ammunition to throw into equities. Of course new fund inflows, presumably from individuals, could change this. And as long as companies can benefit by slashing costs without running out of customers for their goods, stock buybacks can help goose stock prices too.
Of course there is one caveat regarding mutual fund cash percentages. Funds always have to have some cash on hand to satisfy redemptions. And if the market pushes up the value of the fund’s portfolio, and cash measured in dollars stays constant, the portfolio’s cash percentage falls. So this could be part of the reason for current low percentage levels of mutual fund cash.
But back to the video, which recorded a debate between Rosenberg and bond bear James Grant. Rosenberg said that portfolio rebalancing will support demand for bonds, and he also says that the Japanese experience (banking crisis, bank bailouts, economic stagnation, and easy ability for the government to borrow huge amounts) bodes well for the Treasury getting its bonds sold even the unprecedented amounts it now seeks.
Grant took the other side (as I did here): Japan is a poor analogy for us, because it is an export powerhouse. With a large current account surplus, the Japan of the “Lost Decade” didn’t need the kind of international help we do, to get bonds sold. Japan’s GDP and the Nikkei average stagnated in the 1990s but its world-class exporters forged ahead as if nothing had happened (to pick the auto industry, for example, look at Nissan, Honda, and Toyota).
Having said all that, I wouldn’t be surprised if the Fed were thinking the same way as Rosenberg. On the one hand, by keeping rates low, the Fed is forcing institutions out on the risk curve, and this pushed stocks up. But on the other, the Fed could be thinking that fund flows from individual savers will support bonds; the Euromess, which for the moment makes America look good by comparison, could amplify those flows. The Fed and the Treasury can have their cake and eat it, or so that argument would run. I’d be more willing to buy the argument if the Treasury didn’t need to raise trillions of dollars of fresh cash annually to fund deficit spending, while additionally rolling over the $4.5 trillion or so in debt that will mature over the next four years. Is there that much investable money in the world, or will the Fed have to print it? Rosenberg bets that there is, but I am reluctant to take the Japan analogy as far as he does.
Sooner or later, bond rates almost have to go up (do they really have much room to go down?). Assuming Treasury can raise its funds, it will almost certainly have to begin paying more for them in the next several years. Some of us remember that before the secular decline in rates we have enjoyed since 1981, there was a secular increase in rates that lasted from 1941 to 1981. By the end of that bond bear market people called bonds “certificates of confiscation.” I would expect at least some kind of replay eventually.
As far as Treasurys go, I would short TLT if it gets close to resistance at 91. A trader would want to stop out somewhere above 92.50 but I think it’s worth trying to hold longer term, if you can stand the news driven zigs and zags which are sure to keep coming.
Disclosures: Long TBT, short TLT