Bearish CrossCurrents

08/16/2017 2:55 am EST


Alan Newman

Founder, Crosscurrents Publications, LLC

One might conceivably argue we are awash in money. To be more precise, there is apparently just over $312 billion in liquid assets of mutual funds at this time, suggests Alan Newman, editor of CrossCurrents.

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This level is not far from the all time record high of $319.7 billion registered in February 2015. Odds that at least two will occur only 3.3% of equity mutual fund assets, a historically low level.

From 1984, the first year for which we have compiled data, through 1999, just before the tech mania peak of March 2000, cash averaged 8.3% of mutual fund assets, and surged as high as 12.9% in October 1990.

In fact, cash had not fallen below 5% of assets until April 1998, when tech stocks began to be viewed as a oneway road to riches.

Clearly, there has been a remarkable change in the character of the stock market—a metamorphosis.

Much of this change can be pinned on the advent of index funds and passively managed exchange traded funds (ETFs), portfolios that are typically fully invested, with nearly zero cash.

In a rising market, cash is anathema, an obstacle to performance. Thus, in order to compete with ETFs, fund managers have pared cash to extremely low levels, totally relying on bull trends. Ironically, history shows they are likely to be wrong in the long run.

Overexposure, such as we saw at the top in 2000 and 2007, is the primary reason stock prices were cut in half. We believe it will happen again. The factor of actual cash assets near historic highs is totally outweighed by the extreme risk of record leverage.

Not only are the relative cash reserves of mutual funds insufficient from a historical perspective, they are pathetically weak when we consider how much margin debt is in the system.

Total margin debt (NYSE plus NASDAQ) in June was $584.3 billion, only $8.5 billion from the April 2017 record of $590.8 billion. Net liquidity, which we compute by subtracting total margin debt from absolute cash levels, is now minus $272.1 billion.

Although this may seems far from the April record of minus $295 billion, we would take no comfort in the distance from April’s tally.

Make no mistake, risk is greatly underreported and vastly underestimated. The present environment is likely the riskiest in stock market history.

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