Data Brief - Money Markets On The March

Money Markets On The March

Friday, January 2, 2009

Over the past few months, we've discussed the level of assets in money market mutual funds a few times. As a sentiment indicator, watching the ebb and flow of money into these ultra-safe investments can prove effective.

Even during the October scare when the safety of all financial assets - even money markets - was questioned, money flowed into these funds as they seemed to be the "best of the worst".

While assets in money markets have continued to rise, equity-based investments have declined. The chart below shows the percentage of assets in money markets (as of the latest data in November 2008) as a percentage of the total market capitalization of the S&P 500 index.

It's a pretty remarkable chart, showing that if all the assets shifted out of money market funds and into the stocks of the S&P 500, they would gobble up 42% of the entire index. That is far beyond anything we've seen since data became available in 1984.

Such an event would never occur, of course, but it's an interesting way to look at just how much stocks have declined while investors rushed to safe investments. And these aren't just mom-and-pop investors - a large chunk of the assets are from institutional funds that may have a structural reason for using the funds.

Let's look at this another way, that isn't quite as dramatic. The chart below shows money market assets expressed as a percentage of the assets sitting in equity-only mutual funds. With $3.6 trillion in equity mutual funds and $3.2 trillion in money market funds, money markets make up about 90% of equity funds.

That's the most extreme amount in 16 years, surpassing the previous (recent) record of 76% in February 2002 near the trough of the last bear market. But it's a far cry from the 1980's and early 1990's when we saw significantly more money in money market funds than equity mutual funds.

It wasn't until the big bull market and stock market craze of the mid- to late-1990's that more money poured into stock funds than money markets.

There's another related chart we post to the site, which tracks how much equity mutual fund portfolio managers have allocated to liquid investments such as money markets, as a percentage of their total assets under management. But we add a little twist, which is to adjust that amount by the current level of interest rates, and then compare that to what they "should" be holding if they were perfectly logical.

Why adjust for interest rates? Well, if Treasury Bills were yielding 10%, and the expected return on stocks was only 7%, then portfolio managers could add value to their shareholders by simply holding ultra-safe Treasuries instead of risking it in the stock market. So when interest rates are high, we often seen managers allocate more of their assets to short-term Bills.

When interest rates are low, however, there is little reason other than fear of a stock market meltdown to allocate assets to Bills, so we usually see cash positions dwindle during times of low interest rates.

At the stock market peaks in 2000 and 2007, portfolio mangers were holding 3% less cash than they "should" have been holding given the level of interest rates, and how much cash they need to meet redemptions, etc.

Currently, they are holding about a 1% cash surplus. They should have about 4.6% of their assets in cash, but instead they're holding 5.4%. That's the largest surplus since 1996, but it isn't yet to a level that we could consider historically extreme. We'd have to see it rise to more than +2% before we could suggest that.

Interestingly, however, there were two other times other than the present when the cash deficit dropped to -3% as stocks were topping out. That was early 1981 and then again in 2000. After each, the S&P declined for one-and-a-half to three years before bottoming, while the cash premium never made it much higher than +1% near the subsequent stock market bottom in 1982 and just barely 0% in 2002.

Also notable here is that there has been a definite trend against market timing by mutual funds. Many fund charters expressly prohibit their portfolio managers from trying to time the market by moving money into and out of cash - they should be fully invested at all times. Several prominent - and successful - fund managers were fired or left after looking after their shareholder's interests by taking money out of equities. So there's a possibility we'll never see cash surpluses of +2% again.

Overall, the data paints a fairly convincing picture that investors have become, and continue to be, extremely risk-averse and that usually leads to positive long-term stock market performance.

Assets in the safest of instruments have ballooned while stocks staggered, to such an extent that we're seeing multi-decade highs in money market assets compared to stock-related assets or market caps. Even professional portfolio managers have increased their cash reserves more than they possibly should have, though we're not quite to a level there that suggests that they, too, have outright panicked.