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The myth of sidelined cash

By Dr. Don Taylor ·
Monday, June 2, 2014
Posted: 10 am ET

One expression I've always found odd in investing is "There is a lot of cash sitting on the sidelines" or some variant of that expression. Like investors are waiting on the bench for the coach to signal that it's time to get in the market. Why I find it odd is that there are two sides to every trade. You've got an investor buying the security and a dis-investor selling the security. On a net basis, no money has been sidelined.

© STILLFX/Shutterstock.comI'm not alone, or even first to find this off putting. Clifford Asness, managing and founding partner of AQR Capital Management, writing in the Financial Analyst Journal article, "My Top 10 Peeves," actually lists this phrase as one of several the he would politely request that people stop saying. Another is: "It's a stock picker's market," but that discussion deserves a separate blog post.

Money managers' cash positions

Even looking at how much money the mutual funds have sitting in cash falls into this argument. The investment manager may have increased his or her cash holdings, but someone else bought the positions that he/she sold to raise that cash. Investors can look at mutual fund managers' cash holdings as a measure of how investing professionals view the market -- within the constraints of these funds' investment policies.

Money supply and liquidity

An increase in the money supply adds cash to the economy and some of that money can find it's way into financial securities like stocks and bonds. The Federal Reserve has kept the U.S. economy awash in liquidity since the 2008 financial crisis, and stock prices have been bid up with these funds. Will the end of quantitative easing by the Federal Reserve end the bull market in stocks with the Fed no longer adding liquidity to the economic system? The end of quantitative easing doesn't mean that the Fed is tightening, just that they're no longer easing.

Margin loans

The ebb and flow of margin debt in brokerage accounts can increase or decrease the amount of money chasing stocks. Margin debt levels have been falling since the start of 2014, meaning investors are using less leverage in financing their positions.

If you've got money sitting on the bench, remember that when you decide to step in and buy an investment, the person on the other side of the trade has made the decision to get out of that same investment. Liquidity and the growth of the money supply in an economy should be a better sign of whether the stock market will catch a bid and move higher. Periodically rebalancing your portfolio to reflect investment performance, risk tolerance and your financial goals is likely to be a better guide for asset allocation. Read Bankrate's "Time to rebalance investment portfolio?" for a discussion on rebalancing.

What signs do you look for in making investment decisions?

Follow me on Twitter: @drdonsays.

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