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Mutual Fund Cash Levels & NYSE Free Credits at Trader’s Narrative

We’ve touched on the epic amounts of cash that are sitting on the sidelines in money market funds. There is some debate about how positive this is for the market so let’s take a closer look by going over a few details from both sides of the argument.

Money Market Levels
Now that we have stepped away from the precipice (or so it would seem), it may be difficult to imagine the magnitude of fear that drove the vast majority into the safety of cash. At its zenith, we had almost half the capitalization of the total US stock market sitting in money market funds.

Here’s a chart of the aggregate US equity market capitalization compared to the total assets held in money market funds (click to see full size chart):

mutual fund cash levels ratio to equity value Aug 2009 bloomberg

And at the March 2009 low, for the first time in 16 years, US money market funds had more assets than US equity mutual funds: Tsunami of Cash Waiting to be Invested. Since March 9, the value of U.S. equities, measured by the Wilshire 5000, has increased by $4.4 trillion. And from its high the level of total mutual fund cash has fallen by $341 billion.

However, before you get excited and start to think this means we are about to embark on a wild bull market, consider the astute point made by Gestalt: that the increase in money market assets may be a mirage as corporations have shifted short term liquid assets from commercial paper to institutional money market funds.

Mutual Fund Cash Levels
Jason Goepfert wrote an award winning research report in 2004 regarding the signal value of the level of cash held by mutual funds. You can get a copy of the research report from the free trading resource section (Charles H. Dow Awards folder).

As you can imagine, it is an important point in all this is that nominal interest rates are negligible. This means there is little incentive to park assets in cash. But then again, if you follow the strong indications of deflation, the real interest rate is 6.5% - which is actually a significant incentive to just let your money grow (albeit slowly) with near zero risk.

Unfortunately, Goepfert’s research report does not take into consideration inflation or deflation but simply adjusts the level of mutual fund cash levels according to the 90 day T-Bill rate. I’ve sent him a message about this so hopefully when he’s back from vacation he can update it with this new twist thrown in (here it is: Mutual Fund Cash Levels - Adjusted for Inflation).

In any case, right now, this ‘rate adjusted’ model is smack dab in neutral territory. Not helpful at all. It was moderately bullish at the spring low but since then, as the market has improved and as sentiment has thawed, this indicator has backed off into ‘no man’s land’.

NYSE Free Credits
You’re probably familiar with Margin Debt levels, which measure the level of liability in brokerage accounts. Free Credit statistics in contrast, reflect the available, free and clear cash that investors are holding in their trading accounts. This data is released regularly by the NYSE and shows how much liquid assets are held in aggregate by clearing firms overseen by the NYSE.

Speaking of Goepfert’s excellent research, here’s a very long term chart of the NYSE Free Credits, courtesy of SentimenTrader:
NYSE free credits historical chart Aug 2009

This month was the first increase in NYSE free credit in 6 months (you can’t really see it but the most recent data point was a tiny uptick). But on a year to year basis, the shrinkage in free credits was on par with the 1929 crash!

Surprisingly, such sudden drying up of liquidity - after a spike higher - has not been historically a detriment to the stock market over the following 12 months.

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10 Responses to “Mutual Fund Cash Levels & NYSE Free Credits”  

  1. 1 Dave

    “NYSE Free Credits” Great post. Thank you. Hadn’t thought about this since my days as a broker.

  2. 2 tradeking13

    Here’s a riddle:

    Trader A (on the sidelines) buys stock from Trader B (in the game). Now Trader A is in the game and Trader B is on the sidelines with the cash received from Trader A.

    Has any money been removed from the sidelines?

  3. 3 Babak

    Depends on what ‘A’ spends the free credits or cash on from the sale of his stocks. If he buys more stocks, then yes, money has been removed from the sidelines. If he takes it out and buys a boat, then no.

  4. 4 tradeking13

    If Trader ‘A’ buys more stock from let’s say Trader ‘C’, then now Trader ‘C’ is on the sidelines with cash (rinse, repeat). There is always a ton of “money on the sidelines”; it doesn’t dissappear when you purchase stock (or anything else for that matter). The only thing that changes is the agreed upon price.

    Interestingly, I have noticed this argument trotted out when there are no more fundamental arguments to justify market valuation. I heard it a lot in the Spring ‘07, Fall ‘07, and Spring ‘08. Now I hear it again. Next, I expect to hear about how the stock market is cheap according to the IBES/Fed model.

  5. 5 Babak

    So you’re saying that cash levels are irrelevant? re IBES, not again. Once burned, twice shy.

  6. 6 tradeking13

    Let me posit this hypothetical. One morning, every person who owns shares in an MMF decides he/she needs to get into the equity market. So, all the money “pours” in from the sidelines into the market. MMF levels are at zero; the sidelines are empty. How can anyone cash out at this point, when hypothetically there is no cash left?

    There is a reason they call it “trading”.

  7. 7 Tyler

    tradeking13 - that last one is a good one. Admittedly, I don’t have an answer for you right now.

    Twisting the question around a bit: if cash levels don’t change or, as you put it, there is always a ton of money on the sidelines, implying that those levels stay the same…then how do you explain fluctuations in Money Market Funds? Answer that, and you probably have the answer to your original question.

    Yours is a great question though!

  8. 8 Just try

    Re: then how do you explain fluctuations in Money Market Funds? Answer that, and you probably have the answer to your original question.

    “Money” can be invested to all kinds of other assets like bonds or withdrawed to put into bank CD for example…

  9. 9 wayne

    Response to TradeKing’s first riddle,

    If you assumed that equity capitalization equity cash was static, then you could not create more cash supply from any sale because as you pointed out it would be a “zero sum” game.. However it is not static. There is new cash entering and leaving the playing field from various sources such govt money printing, the creation of new companies and asset materials such as precious metals, existing companies issuing new stock or repurchasing existing stock, sell and purchase of other assets such as real estate and commodities, not to mention the interaction with foreign assets. In a recession/depression, cash leaves the playing field to pay other living expenses that it would not normally be needed for.

    Your second hypothetical, where everyone purchases at the same time is simply the converse of your first riddle. If all the cash decided to buy, The equity players who sold would then become the cash pool. If they in turn decided to turn around and rebuy equities, then the process would continue to cycle. But every time there is a sale, the seller, is momentarily left with cash.

    Another separate comment is that the money market supplies don’t change as much as does the relationship to the sum totals of cash and equity.

    For example purposes, assume that 3 players comprised all the equity assets and cash assets in the playing field and assume that

    Player A owns 1 trillion in equities
    Player B owns 1 trillion in equities
    Player C owns 1 trillion held in temporary cash (mm) account.

    Assume no new players or cash enter the game.

    The % of cash to equity Cash is 33%

    Now assume that equity prices have decreased by 50%, similar to 2008-09. Now all of sudden

    Player A owns 1/2 trillion in equities
    Player B owns 1/2 trillion in equities
    Player C still owns 1 trillion in cash

    Now the % of Cash to Equity Cash is 50%, but the actual cash amount has not changed.

    Now assume Player C decides to buy equities with all of his cash. Then the relationship would become

    Player A owns 1/2 trillion in equities
    Player B owns 1/2 trillion in equities
    Player C owns 1 trillion in equities.

    The % of cash to equity Cash is still 33%, it has simply been redistributed. But the point is that the % of cash moved from 50% to 33% based solely on price of equities and not who decided to buy or sale.

    Again this is all theoretical based on a static capitalization playing field and I point out again that the cash in the playing field is not static, but usually growing due to inflationary pressures and a litany of other reasons, some of which I pointed out in the first paragraph.

  10. 10 tradeking13

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