Michael Santoli

A Trillion Here and There: Will All That Cash Move on Cue?

Michael Santoli

It’s surprisingly easy to pledge a trillion dollars toward a favored cause. The money, of course, doesn’t always cooperate by hustling along the promised path.

There are essentially two pools of about $1 trillion sitting in places where lots of people feel it doesn’t belong. So they are calling for it to move elsewhere.

A trillion dollars is approximately the cumulative amount that investors have shoveled into bond mutual funds since 2008, while pulling a net $400 billion or so from stock funds. The popular market prediction for this year is for this money to begin hastily shifting back toward stocks, which is one reason lots of market commentators got overexcited in extrapolating two weeks of strong stock-fund contributions this month.

The other trillion-dollar stash is on the books of the companies in the Standard & Poor’s 500 index, which have spent the past several years allowing cash to pile up as they focused on expense control to pad profit margins, rather than hiring and investing aggressively.

A complicated tale

Of course, with such vast sums controlled by so many different economic actors, the story gets more complicated the deeper one digs into the numbers.

There is no doubt that the public’s preference of bonds at the expense of stocks since the trauma of the financial crisis appears extreme. And with the trailing three-year returns on stocks now showing a wide advantage of government and corporate bonds, it would be natural for some more cash to shift toward stocks at the margin.

This is just about the time in a bull market -- with the Dow having doubled over nearly four years and stock values no longer cheap –- when the little guy begins to warm to stocks again, often propelling the uptrend’s final excitement phase. As Doug Ramsey of Leuthold Group has noted, retail investors tend to buy most when stocks have become more expensive, and vice versa.

Yet the increasingly urgent calls for a “great rotation” from bonds into stocks, which would purportedly carry equity indexes much higher, misread the way investor preferences tend to shift, and gave too much credit to retail buying and selling as a driver of market performance.

Individual investors tend not to make sudden moves in the aggregate unless they are reacting to sudden shocks to their portfolios. The bond market has remained quite strong, even with Treasury yields backing up a bit lately, and investors who are playing there are sitting on a lot of "house money."

The "great rotation"

If a shift starts to gather strength, it would likely be after some shakeout in the bond market -- which might or might not be associated with choppiness in stocks as well. Basically, a “great rotation” now would require that public investors “stick the landing” by turning away from bonds at the perfect culmination of a 30-year bond bull market. That’s not exactly the way it usually goes.

The $34 billion added to stock funds in January has been celebrated as a broad, overdue rediscovery of stocks by Americans. Yet consider that $30 billion was pulled from equity funds in December, and some $25 billion was taken out of the market by individuals as special dividends last quarter. We're perhaps just seeing some portion of that cash spill back toward equities.

Besides, the market has proven, by doubling without the public throwing money at it, that Main Street need not be involved for Wall Street to flourish. Any amount of capital sluiced into stocks by families would be dwarfed by the trillions of yen being dumped by Japan for global investment funds to borrow and invest, not to mention Western central banks' monetary looseness.

As for corporate cash, the apparent surplus of idle liquidity is not a new story; the cash is quite concentrated in a handful of lushly profitable companies and much of it is effectively offset by a boom in corporate debt issuance over the past few years.

For at least three years Corporate America’s large cash cushion has been a common talking point. It certainly has supported stock valuations in market pullbacks, and puts companies in decent shape to deploy cash as opportunities arise. By most every measure, big companies have more cash flow and corporate savings than they have good ideas about how to use it.

Less than meets the eye

Yet more than half the cash held by all non-financial companies in the S&P 500 resides within the two dozen largest companies, led by the $137 billion in Apple Inc.’s (AAPL) larder. And most of the cash among the most liquid multinationals is held overseas, as companies avoid paying U.S. taxes on foreign profits. There’s a lot of cash there, but for practical purposes less than meets the eye.

The average company is in decent financial shape. Still, the amount of debt assumed by investment-grade issuers, relative to their total assets, has rebounded strongly. Companies have shrewdly seized on radically cheap borrowing costs to lock in low interest rates, frequently using the proceeds (which fatten reported cash holdings) to buy back their shares or invest in labor-saving technology.

Put this together with the fact that the world’s nominal economic growth rate has been subdued, and it’s clear there is nothing terribly odd or perverse driving companies’ cash accumulation.

As with the potential for investor cash heading back toward stocks, the cash at companies’ disposal serves as potential energy to quicken economic activity and boost asset values. Together they hold the prospect of a market “overshoot phase,” in which a self-reinforcing chase of higher share prices and rekindled corporate acquisition appetites get rolling. Deal activity, in particular, seems poised to accelerate, making it one of the key themes to watch in the market this year.

But just because it makes sense on paper doesn’t mean it will all come together on cue.

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