Cash a False Savior? Funds' Fat Cash Stakes May Stay on the Sidelines

In the hunt for some bullish signals amid the ugly market selloff, some folks are pointing with hope to the cash mounting up in mutual funds -- cash that's just waiting to be poured back into the market.

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But if long-term mutual fund cash levels are any indication, that ocean of cash might not flow into stocks any time soon.

Rising cash positions in stock funds in recent years have presaged steep gains in the stock market, because when managers use that money to buy stocks, they can send prices north in a hurry. But this simplistic relationship between cash levels and stocks prices might not hold true in the coming months, mainly because there's not much reason for managers to put their cash to work.

One veteran scoffs at tracking cash-level fluctuations in funds for signs of the bull. Says Bill Nygren, a portfolio manager with Chicago-based Harris Associates who has some 20 years of experience: "It's just random noise. Looking at a 1 percentage point rise and drawing conclusions is silly," says the manager of the (OAKLX Quote)Oakmark Select fund. "I think people are struggling to find an indicator that's bullish."

One undisputed point is that cash is rising in stock funds. At the end of October, the average U.S. stock fund had 6% of its money in cash, a 13% jump from Sept. 30 and the highest cash stake in two years, according to the Investment Company Institute, the mutual fund industry's trade group. Liquidity tracker TrimTabs.com estimates more recent cash stakes at some 6.5%, a level not seen since November 1987. (TSC examined rising cash levels in funds, such as several funds run by Janus.)

Recently, rising cash has been a good sign for the market, while low cash levels have been bad news.

"Back in September 1998 when cash was 6.3%, the S&P 500 returned 26.5% over the next six months," says Phil Edwards, managing director at Standard & Poor's funds unit. "Then in March 2000, when cash was at 4.3%, the S&P lost 6% over the next six months. So there is some correlation between cash levels and market performance."

But that relationship might not hold true now because managers might be perfectly happy leaving that money in the bank.

"A lot of cash on the sidelines is traditionally considered a bullish indicator, but I think what people are missing is that the low cash positions of recent years were aberrations. The current levels are more in line with [cash positions in] the 1990s," says senior Morningstar fund analyst Scott Cooley.

In fact, they're a bit low. Between January 1990 and this past October, funds averaged a 7.4% cash stake, according to the Investment Company Institute.

Got Cash? Current cash levels aren't very high compared with previous levels
Year	Cash Levels of Funds on Average
1980	9.6%
1981	9.4
1982	10.2
1983	9
1984	9.2
1985	9.3
1986	9.5
1987	9.6
1988	10.2
1989	9.9
1990	11.8
1991	8.2
1992	8.3
1993	8.4
1994	8.3
1995	7.5
1996	6.9
1997	6.4
1998	5.5
1999	4.8

Today's tough market environment might also keep money on the sidelines. Cash levels dipped every year from 1995 through 1999, finally ending up under 5%. Not coincidentally, that was the first time the S&P 500 strung together a five-year streak of returns over 20%.

"With the S&P 500 going up 20% each year, there was a very real penalty for holding cash," says Cooley.

With the S&P 500 down 11% on the year and the Nasdaq Composite off more than 38%, there isn't the same pressure to be "fully invested" in stocks. And with investors about to receive disappointing year-end account statements, some managers might be holding extra cash to meet potential redemptions.

Even if cash is a divining rod for market moves, profiting from a gush of fresh cash would mean accurately anticipating where it was going.

"I think it's a tough idea to play," says S&P's Edwards. "Over the last couple of years, cash all went to technology stocks and large-cap growth stocks. Now the cash might spread out and you might not get as big a jump."