I am often fascinated by some of the explanations people use to rationalize a rise in the stock market. I am sure you've heard people ascribe it to "too much cash on the sidelines."
What does that mean, anyway? I take it to mean bank deposits. That's the most logical thing, because what else can it mean? Cash can only exist in bank deposits -- at least, the kind of cash that brokers will accept for payment of shares.
The market's rally of the past few months does make sense when you look at the trend in bank deposits: They have been going up hand in hand with the stock market.
You see that pullback in March through the beginning of April? We did have a market correction at that time; but then bank deposits started heading back up again and the market rally resumed.
Bank deposits are created in three ways. They are created when banks make loans (loans create deposits.) They are created when the government spends (you get a social security check, boom! A deposit is created.)
They can also be created when the Fed does certain operations, like reverse repos. In that case, the Fed will sell Treasuries or some security to a counterparty and debit the counterparty's checking account. Then, when it buys back the security, it will usually buy it back at a premium.
Reverse repos are a way of crediting the banking system with reserves. It is used to add interest or pay interest on reserves, and that's exactly what the Fed has been doing as a result of the rate increases.
In recent weeks, there has been a drop in bank deposits actually larger than the one we saw back in March. Take a look. The chart below is the weekly change in deposits. You can see it more clearly when presented that way.
That's a pretty big drop, as you can see. Deposits have gone from up $41 billion to $27 billion. It's as big as the drop in March, and again, that's when we saw a correction. That's not to say the same thing will happen now, but then again, maybe it has already started.
While the Dow and S&P just kited to new highs, the Nasdaq has not, and it was the Nasdaq that led this rally since March and it may be the index that leads it down now.
Bank deposits are the closest thing that I can make out to what people mean when they say there's too much cash on the sidelines. If I come across as looking for a reason for the market to go down, that's because I am. This is the same phenomenon we are experiencing as any crash, but in reverse.
Fear has gripped investors, and that is the fear of being left out. Yet there are certain things that are immutable. That is, there needs to be money to push stocks higher, plain and simple. And the money available has shrunk. You can see it. I can also tell you that fiscal flows, while they were expanding at a modestly faster pace from March through early May, slowed since the May 8 budget deal.
I can only go with what has worked in the past and what makes logical sense. Over time, stocks rise because, like I said many times, the stock market is a growth function. It discounts the growth of earnings and innovation and the growth in societies and economies and the desire of people to improve their conditions and strive to achieve and earn and produce more.
However, within that paradigm there are times when it is prudent to raise cash and move to the sidelines. These are those times.
This article originally appeared at 09:00 ET on Real Money, our premium site for active traders. Click here to get great columns like this from Jim Cramer and other writers even earlier in the trading day.