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Cash Hoarded, Conviction Lacking 

07/09/2009 2:42 pm EST


Kelley Wright

Managing Editor, Investment Quality Trends

Kelley Wright of Investment Quality Trends notes a dearth of equity fund inflows, and institutional buying despite attractive valuations.

The default analysis at mid-year for many market observers is to simply rehash the first six months, highlight the data and news they find compelling, then extrapolate same into a projection for what that portends in the markets over the coming six months and beyond. While some of the above can be entertaining and perhaps even interesting, it can easily become a distraction from what is really important; the primary trend and the action of the market.

The primary trend of the market (the DJIA) turned negative in October/November 2007. From September 19th, 2008 until November 20th, 2008, the market went into waterfall mode, rallied briefly until January 2nd, 2009, then resumed the waterfall into the March 9 bear market lows. Since March 9 the market has been in a secondary trend, which we call a bear market rally.

Obviously no one knows which direction the market will move next, however, the market does provide clues along the way by its price action. If the Dow were to decline below 8,000 it would be a blow psychologically; a break below 7,500 would almost guarantee the end to the secondary trend and a re-test of the March 9 lows. On the flip side a close above the January 2 high of 9,034.69 would provide a psychological boost and represent the first retracement objective of 1/3 of the bear market declines. A strong follow through would suggest the likelihood of further gains and set investor sights on the second retracement objective of 1/2 of the bear market declines at Dow 10,300.

As we wait for the market to deliver its verdict, many bulls and bears will attempt to get ahead of the curve by anticipating the markets’ reaction to the steady stream of news and information emanating from the economy and the body politic.

That there is always news and information from these two fronts, economics and politics, is missing the point. With the markets battered and the global economy in shambles, investors have a heightened sensitivity to what is disseminated and how it is synthesized.

The social safety net that has been expanding since the 1960’s, both by state and federal governments and the private sector (read GM), is collapsing from the weight of promises [that] can no longer be [kept]. My home state of California is in virtual meltdown and may become the poster child for what could befall other states, the federal government and more of the private sector.

With the above as a backdrop, it is no wonder that investors are sitting on a mountain of cash. My friend Madeline Schnapp at TrimTabs MacroAnalysis reported that from March through May investors directed $615 billion into Treasury securities and FDIC-insured savings accounts. Equity mutual funds reported outflows of $1.8 billion. With Treasuries yielding 1/3 of 1% and savings accounts just slightly more, it is apparent that the need for safety is trumping the desire for return.

With investors seeking refuge in cash and equivalents and equity mutual funds experiencing net outflows, it must be the institutions doing the bulk of the buying. Interestingly though, when looking at the measures of large institutional buying and selling that topped and bottomed respectively last October, we find little in the way of expansion and contraction. If the institutions aren’t in and neither is the public or equity funds, it [raises] the question of just who has been buying since March 9.

With all that has transpired since January in Washington, DC, the state capitols, the economy, and the private sector, it may have been easy to forget the infusion of cash many large institutions received after the Lehman collapse, before the Bear Stearns bailout and prior to the TARP and TALF programs. I suspect at some point we will learn this is where the buying has come from: the Feds’ money.

Putting the above aside, the first half was not unkind to the market of high-quality, dividend paying stocks. While many shares enjoyed high single-digit to lower double-digit gains, not all of the opportunity has been taken off the table. Good historic value is still to be found and as the pending Climate Change Bill is either watered down or defeated all together this summer, look for energy and utility shares to reap the benefits.

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