Investors Holding Their Breath

If it feels like the financial markets are lurching from news event to news event in recent weeks, you're right. They are. After a strong first half, investors are wondering if the good times are over or if the positive momentum of the economy and stock market will continue.

Last week, investors were on pins and needles waiting for Fed Chair Powell to deliver his talk at the Jackson Hole event. Although everyone seems to be second-guessing what Mr. Powell says, he has so far not deviated from what he says to what the Federal Open Market Committee (FOMC) actually does. Mr. Powell has provided accurate insights on the concerns and possible strategies FOMC committee members are considering, along with economic indicators that may trigger certain actions.

Illustrated in the chart below, as of August 24, 2023, total cash on the sidelines has climbed to almost $1.6 trillion (almost 10% of the US GDP). This chart indicates that the selloff of 2022 still lingers on the minds of lots of investors as they are steadily growing their "safety nets."

Monitoring cash reserves is an excellent indicator of the potential direction of the stock market. Stock prices rise and fall depending on the inflow of new cash into stocks. If cash flow to buy new stocks is declining, then stock prices typically decline with greater seller demand than buyers. Conversely, when cash is flowing into stocks, prices rise with greater buyer demand than sellers.

Cash balances, along with stock trading volume, are indicators of the investing trends of investors. During market rallies that are reaching the top of the momentum, cash balances are nearing new lows, and trading volume is very high. Greenspan cited this very phenomenon during his televised speech on December 5, 1996, regarding the building dot.com stock bubble:

"Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?"

— "The Challenge of Central Banking in a Democratic Society," 1996-12-05

Both Warren Buffet and Federal Chairman Alan Greenspan questioned the validity of stock prices in 1996. They were both right and wrong. While their assessment of the stock market was correct, they were four years early with their prognosis. If investors followed their advice of caution, they would have missed extraordinary returns during the next four years. The S&P 500 rallied 97%, and NASDAQ exploded with a 213% gain. Many tech stocks increased many more multiples than the NASDAQ, which turned average investors into millionaires.

When cash reserves reach high levels and above-average balances as they are now, the potential is at some point, institutional and private investors will begin transferring their cash savings into stocks. The delay in these transfers is coupled with concerns about the economy, Federal Reserve raising rates, and concern the first half-year rally is running out of momentum. Another factor is investors have capitalized on fixed-income accounts that include Certificates of Deposits and Treasury Notes that offer yields of around 5% but are locked up for nine months or more. Many investors are waiting for these accounts to mature before they can invest in the stock market.

What Does It Mean To Me?

When overall trading is thin (like in August when many investors are on vacation), the market is prone to stall. After Labor Day, school will be in full swing, and most market players will be back at their desks. Also, more information about the potential holiday season and third-quarter earnings will be available for investors. Our view is when the market begins to recover from the weak August pause, some of the cash reserve funds will start to flow into the market and may continue to flow into the market well into 2024.

Today, the S&P 500 crossed above both its 20-Day Moving Average (DMA) and 50 DMA. As a result, we will be investing the higher-than-average cash reserves in our model portfolio. Our decision is based on our positive overall view of the US economy and stock market.

September and October have experienced historic volatility, but we are more focused on the potential gains of the stock market over the next 18 months.

Let us know if you have any questions about this Weekly Brief or your personal financial planning. We welcome the opportunity to be of assistance to you and your family.