Don't Count On a Sideline Rally

Cash is building up in money markets, but most of it is from institutional investors.
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There's a mound of money on the sidelines. While the major averages have tumbled, investors have steadily shifted out of stocks and into cash. And when the trend inevitably reverses -- when the economy bottoms, which it must -- investors will flee the safety of low-yielding money market funds for the higher returns available in the stock market. A rip-roaring rally will follow!

Oh, if only it were so. Unfortunately, the well-worn argument that a wave of money market cash is about to wash up against the equity market has a number of holes in it.

Though it is true that the growth in money market fund balances has accelerated through this year, the first thing to note is that that growth has nothing to do with individual investors. The latest data from the

Federal Reserve

show the level of cash in retail money market funds (those with a balance of less than $100,000) at $1.02 trillion, about 11% above where it was a year ago. That's about as meager a rise as there's been in the last five years. The shift toward conservatism that some people expect to see from aging, boomer-era retail investors has yet to surface here.

The big shift toward money market funds has been on the institutional side. There's $1.01 trillion in institutional money market funds -- a whopping 47% more than there was a year ago. But this rise probably has more to do with what's going on with the economy than with what's going on with the stock market. Though big investors obviously use money market accounts to park cash in, so does

Caterpillar

.

When times are flush, U.S. companies like to put their money to work. They raise inventory levels to ensure demand will be met. They hire more workers, build plants and buy spanking-new equipment to boost production. But when the economy goes sour, like now, they cut those inventories, freeze hiring and cut back on capital spending plans. That leaves them with more cash on hand.

Meanwhile, financial institutions, less willing to lend money in a dangerous economic environment, also shift more cash into money market funds during a downturn. And for these outfits, points out Credit Suisse First Boston bond market strategist Mike Cloherty, money market funds have an added allure -- their yields adjust slowly enough in an aggressive easing environment that it's possible to play the spread between their returns and actual market returns. "They're posting above-market yields a lot of days," he says.

Mounds of Moolah?
Retail money market fund levels are hardly surging

Source: Federal Reserve

But maybe you can still argue that low money market yields are going to force investors into stocks. The 2.3% yield on the average money market fund is hardly the kind of thing to build retirement dreams on. (Heck, it's going to have a hard time keeping up with the rate of inflation.) Moreover, even if retail money market fund balances aren't growing all that rapidly, they still are growing. Meanwhile, the decline in stock prices has brought down the equity portion of investors' portfolios. Investors could conclude that on a percentage basis, they're holding too much cash and too little equity.

But low money market returns, or the stock market's history of giving very good returns, are not alone going to create that shift. Consider the Tokyo stock market, which has been mired for years, despite interest rates near zero. "Did the Bank of Japan push people out of safe deposits into the stock market?" asks Banc of America Securities equity portfolio strategist Tom McManus.

Stocks will first have to offer some stability, then some steady growth, to persuade investors to meaningfully raise equity positions. Even then it will be hard. Many retirement portfolios are no better off than they were five years ago, and now, of course, retirement is five years closer. This is not to say that stocks cannot go meaningfully higher in the year to come, only that if they do, it will be for strong fundamental reasons -- not because of a wave of money that probably isn't even there.