The path to economic and financial market prosperity that Wall Street keeps talking about has a boatload of money behind it. Here’s how that breaks down.
Central bank stimulus throughout the globe was powerful in the beginning of the year, as the coronavirus pandemic decimated the world economy. With interest rates drastically lowered and capital injected -- from central banks and governments -- into the hands of investors, small businesses and households, the money supply has skyrocketed. Consumers and businesses have indeed picked up spending increasingly each quarter of the year, but cash still sits on the sidelines. And it’s ready to be deployed into the economy and financial market, which can provide major support to asset prices.
Cash sitting in money market funds is currently about $4.7 trillion and cash sitting in as bank deposits currently totals to almost $6 trillion, according to global strategists at Morgan Stanley. They are record absolute amounts by a wide margin.
On a relative basis, the story is unchanged. As a percent of GDP, money market fund assets are 23%, higher than in 2009 during the financial crisis, when the ratio was just above 20%. Just before the pandemic, cash in money market funds was 18%. Bank deposits are about 26% of GDP, compared to just above 15% during in 2008 during financial crisis and 18% just before the pandemic.
“If history is any guide, the Morgan Stanley strategists say, cash as a percentage of GDP should fall to 15% or below. The strategist say some of the cash will move into treasury yields, adding pressure to interest rates, but not enough to offset an economic recovery that should take rates up -- and many think the 10-Year Treasury yield can soon move to 1% from below 0.8%.
For money market fund assets specifically, a return to 15% of GDP, with GDP at roughly $21 trillion annualized, the total could fall by about $1.5 trillion to just over $3 trillion.
As for bank deposits, consumers may be set to spend soon. Sure, consumer spend has increased by the month since the throes of the pandemic in April and May, but consumer confidence is still low and cash is stowed away safely. This only means when consumer confidence picks up, so will spending, so will inflation and so will corporate revenues.
Consumer confidence is sitting at a reading of roughly 100 of late, according to data from JPMorgan equity strategists. It was at 130 for over a year leading into the pandemic and the last time consumer confidence was this low was 2016.
“Investors are likely to see a continued recovery in coming quarters,” Michael Sheldon, chief investment officer at RDM Financial Group, told TheStreet, adding that this is especially true if vaccines and fiscal stimulus remain a significant part of the equation. Fiscal is important because consumers and businesses can spend now, but a sustainable stream of income is dependent on small business reopening and higher employment. Interest rates cannot fall much from here. Added cash must come from organic economic growth or fiscal stimulus.
So if consumers and businesses remain prudent near-term, they could inject cash into the economy soon.
One sector that could see an outsized benefit from this would be consumer discretionary, a largely value-oriented sector from an investment perspective. Here’s an overview of value stocks at large.
Large cap value stocks are up about 10% since the end of June. Earnings have beaten estimates, which have been revised higher, slightly, on a forward-looking basis. And with the 10-year yield where it is, valuations are not expensive, although they do vary a bit across sectors. U.S. large cap stocks are indeed trading at their 90th percentile of valuation, historically, according to Glenmede research. However, Glenmede points out that large cap tech, wildly outperforming the market the year, is responsible for much of the valuation in large caps. Interest rates are so low that "rather than abandoning equities wholesale, investors should seek value within equities to avoid taking risk off the table,” wrote Glenmede's Chef Investment Officer of Private Wealth, Jason Pride in a note.
In aggregate of large caps, the equity risk premium -- the expected earnings yield on S&P 500 stocks for the next year minus the 10-Year Treasury yield -- is close to 4%. Historically, the number can hum at around 3.5%, indicating higher stock prices on a relative basis. Large-cap tech is responsible for much of the valuation surge since March this year, leaving value more attractive.
Away from large cap, U.S. small caps are trading closer to fair value compared to their history and many on Wall Street see opportunity in that class of stocks. Small caps are trading closer to their 70th percentile of valuation, but once again, rates must be taken into consideration.
The point: value investors should be patient, but a return to normal and higher confidence in the economy should translate into big gains away from growth tech.