by Larry Levin
The piece below is an interesting perspective on the issue of "cash on the sidelines." How often have you heard an analyst say on television "there is X-amount of cash on the sidelines and therefore it is just a matter of time for it to plow into equity shares and..." yadda, yadda, yadda...the Dow is magically at 46,000.
Really? When you buy one or 1,000 ES mini-SP do you drive the market higher with the "new cash" in the market or has someone really simply sold you his? It is just a transfer of positions from one entity to another. If nobody was "aggressive" and paid the offer at ever higher prices, buyers and sellers would trade on the bid and offer all day. Without aggressiveness the market would go nowhere and billions could trade per day - simply transferring ownership back & forth at the same price - with no change at the close. I see it every day.
Although I have explained this many times in my life, the following piece by John P. Hussman, Ph.D. covers it in detail.
The original link and full article is here
http://www.hussman.net/wmc/wmc060710.htm
There's No Such Thing as Idle Cash on the Sidelines
"No, but you're... you... you're thinking of this place all wrong. As if I had the money back in a safe. The ... the money's not here..."
- Jimmy Stewart in "It's a Wonderful Life"
There was a farmer who harvested his field of corn. He sold all but 100 bushels. A few weeks later, he lent the 100 bushels of corn he had saved to a cereal maker, who gave the farmer an IOU that said "100 bushels of corn," made a big box of corn flakes, and sold it. The next year, a famine struck. People looked hopefully at the farmer, seeing the note that said he had 100 bushels of corn. All that corn, just sitting on the sidelines! If only the farmer would put that corn on the sidelines to work, they thought, then everything would be fine...
One of the hurdles in thinking properly about the financial markets is to understand the idea of "equilibrium" - that all securities issued must be held; that savings must equal investment; that every share bought by someone must be sold by someone else.
... and that there's no such thing as "idle cash on the sidelines."
That last one isn't easy to grasp. After all, you can look at your own brokerage account and say - "look right there at that cash balance. There it is, on the sidelines, just waiting for me to put it into the market."
But if you look more closely, what you really have is an IOU. It might be a very liquid one, like a money market fund that holds T-bills and commercial paper, but it's still an IOU. See, your "cash on the sidelines" isn't sitting there idle, waiting to be put to work. The fact is that it has already been put to work.
And when you go to put your "cash on the sidelines" to work, what really happens is that your money market securities (T-bills, commercial paper, etc) now have to be sold to someone else. And at that moment, the cash on the sidelines that you had suddenly becomes somebody else's cash on the sidelines. And that same amount of cash on the sidelines will continue to exist until the borrowers pay it off.
Likewise, investors should not believe that the "cash on the balance sheets" of corporations might suddenly be used, in aggregate, for new investments and capital spending. That cash on their balance sheets has already been deployed as loans to the Federal government and to other companies.
Now, yes, if the government runs a surplus and retires its debt, in aggregate, or the other companies that borrowed the money generate new earnings and then pay off their debt, in aggregate, then those new savings that retire the T-bills and commercial paper then make it possible for the recipients to finance new investment, in aggregate. So as usual, savings equals investment, and new savings can finance new investment. But what investors often point to and call "cash on the sidelines" is really saving that has already been deployed and used either to offset the dissavings of government or to finance investments made by other companies. Once those savings have been spent, you can't, in aggregate, use the IOUs (in the form of money market securities) to do it again.
In other words, the amount of cash that investors hold "on the sidelines" is determined by the amount of borrowing that has occurred in the form of money market securities like T-bills and commercial paper. It's a lapse of proper thinking to believe that investors, as a group, can move their "cash on the sidelines" into the stock market, or that companies, taken together, can turn their "cash on the sidelines" into new investment and capital spending.
I've said this before, but it's important. If Ricky sells his money market shares and buys stocks, then his money market fund has to sell commercial paper to Nicky, whose currency goes to Ricky, who uses it to pay for the stock bought from Mickey. In the end, the currency that Nicky held is now held by Mickey, the commercial paper held by Ricky is now held by Nicky, and the stock held by Mickey is now held by Ricky, and there is exactly as much stock, commercial paper, and currency outstanding as there was before. All that happened is that the owner of each security has changed.
The price of any given security may or may not have changed as well. For example, if Ricky is very eager to buy stocks and Nicky and Mickey are happy with their existing positions, then Ricky probably has to sell his commercial paper to Nicky at a discount, and has to buy the stock from Mickey at a premium. What happens here is that Ricky has to sell more units of commercial paper for a given amount of cash, and more units of cash are required to buy a given amount of stock. So in this case, commercial paper prices fall (interest rates rise) and stock prices rise.
In contrast, it might be that Mickey is eager to sell stock and Nicky is eager to buy commercial paper. This is good for Ricky. In that case, Ricky might sell his commercial paper to Nicky at a higher price, while buying Mickey's stock at a discount. In that case, commercial paper prices rise (interest rates fall) and stock prices fall.
As a final note, we might know that, say, Mickey, tends to be a poor investor, and generally gets out of stocks after significant declines and gets into stocks only after significant advances. So, we might very well want to monitor the amount of cash that Mickey holds. But in this case, the amount of cash held by Mickey isn't a useful indicator because it measures potential "inflows into the stock market" - rather, it's useful because it's a sentiment indicator. It's still true that in aggregate, the cash is going to stay on the sidelines.
In any case, stock prices don't change because money goes "into" or "out of" the market. Prices change because buyers are more eager than sellers, or vice versa. If a dentist from Poughkeepsie is eager to buy a single share of General Electric (which has about 10 billion shares outstanding), and pays $33.30 instead of $33.20 for that single share, that one trade will increase the stock market's capitalization by a billion dollars. But at the end of the day, all securities that were originally in existence are still in existence, and there is just as much "cash on the sidelines" as there was before.
The upshot here is that investors should never look at "cash on the sidelines" as an indicator of potential buying pressure. It just isn't so. The cash is going to stay on the sidelines until the underlying debt securities are retired.
There is an important reason for these considerations here. As I've noted in recent months, it's likely that China and Japan will at least stabilize in their willingness to absorb the flood of government liabilities that they've been snapping up in recent years. That means that more of these liabilities will be forced into the hands of U.S. investors. As that happens, we're likely to observe an accumulation of "cash on the sidelines" that might look like a hopeful sign for stocks. It will be helpful to remember that the accumulating pile of "sideline cash" actually represents money already spent.
Previous Day's Trading Room Results:
Trade Date: 3/16/10
E-Mini S&P Trades*
(before fees and commissions):
1) FT buy at 1:04pm @ 1149.25 = +2.00 (1 lot)
3) Algorithm positions (7)
4) "Reading the Tape" positions (11) ...combined Secret's, Algo, & "Reading the Tape" total...+2.00
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