Where's All That Cash?
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Have you noticed the tendency lately for the market to respond well to bad news? The meme becomes, this market is so strong that nothing can stop it! Eventually something does, but until then we hear lots of commentary about why the market really should go up for the foreseeable future.
Which of these haven't you heard yet?
- The bad news was already priced in.
- This is the normal stage in a bull market when P/E's expand. (Oh, great! Now we understand. Things are looking so good that we should want to pay more for the same or declining earnings.)
- No matter what happens, the Fed stands ready to add more stimulus.
- Slow, grinding recoveries always produce extended bull market runs.
- Tail risk has been removed. (There are no longer any events that could shock the market. Central banks have everything under control.)
- This has been a hated rally since it began. All the underperforming funds are being forced to go long so they don't get left even further behind.
- Cash is "on the sidelines" waiting for the right pullback to come in.
- Country "X" has turned around (frequently China).
- So many are hoping for a pullback that it probably won't happen.
- With interest and bond rates this low, where else are you going to put your money?
No doubt you could add some of your own, but the main theme is that nothing can stop this rally. In the list above, some of my favorites are the dreaded cash on the sidelines and all those large funds that presumably sat the whole rally out and now have to chase it.
But is there some way to measure this stuff? Can we look for some index of how underinvested everyone is? Can we get a bit more hard data than the bullish/bearish percentage of stock newsletter writers? Is there some way we can access behavior rather than sentiment?
One way we might do this is by looking at what is actually happening in brokerage accounts across the country. Despite what I may say in a sentiment survey, if I really don't think the market is likely to go higher I'm probably not heavily invested: perhaps a few favorite equities, a bond fund, maybe a few shares of GLD –and lots of cash in the account (...hmm, maybe some of that cash on the sidelines...). On the other hand, even if I say I'm worried that the market may not go much higher, but I've maxed out my buying power and am on margin –you might conclude that I was behaving extremely bullishly.
It turns out that we can access this data. All NYSE member organizations are required to report the aggregate margin debt their account holders have at the end of each month. The more margined the accounts, the more this behavior shows that account holders believe that nothing can stop this rally.
The following chart shows margin debt levels in all accounts and is reported at the end of each month (with a lag). To make it an easier comparison with market data for Excel, the data point for the S&P 500 each month is, somewhat arbitrarily, a 5 day moving average of price on the last trading day of the month. Data for the amount of margin debt is only available through the end of February, though I extended the S&P data by one additional month to show it as of the end of March, thus including the new all — time high for the S&P. Price level for the S&P 500 (blue) is the left vertical axis. Margin debt (red), in millions, is the right vertical axis. The top of the scale is half a trillion dollars in margin debt.
What this chart is showing is that, despite the lack of participation in the rally that you hear about, account holders are acting so bullish that they have a near — record amount of margin debt. The actual record debt level (3.9% higher than now) occurred at the end of July 2007, about two months prior to the actual market peak. Margin debt in the year 2000, while not nearly as high as it is today, was a fast ramp to its peak level which happened in the same month that the S&P topped. In each case of an important market top, the pace of margin debt ramped quickly into the peak. Today is no different though the absolute level is slightly lower than in 2007, but much higher than in 2000. You can't see it well on a monthly chart, but note that the increase from January to February was fairly small (364 to 366) — and this could be peaking here.
Gosh! What happened to all of that cash on sidelines?
(c) Bill Hardison