The U.S. stock market already is up sharply in 2019, with the S&P 500 Index rising by nearly 23%. Yet it has the potential to advance even higher if growing optimism about a trade deal and the economy prompts cautious investors to shift part of their massive $3.4 trillion cash hoard into equities. While large cash positions often are interpreted as a bearish sign, strategists at Bank of America Merrill Lynch and UBS have a bullish interpretation.

“We take it as an incredibly positive sign on a contrarian basis,” Jared Woodard, global investment strategist at BofAML, told The Wall Street Journal in a detailed report summarized below. Paula Polito, the global client strategy officer at UBS Global Wealth Management, agrees. "Investors are holding large cash balances in a wait-and-see mode, even though nearly 50% anticipate higher stock market returns in the next six months,” she says.

Key Takeaways

  • Money market fund assets are rising, and at a 10-year high.
  • This reflects caution by investors, but also can be a bullish signal.
  • This cash can spark a surge of stock buying, as confidence rises.
  • Some investors who raised cash have become more optimistic.

Significance For Investors

The $3.4 trillion cash figure cited above reflects money market fund balances as of Oct. 2, 2019. Money market funds have enjoyed net inflows nearly every week since May, and now have about 14% more assets than at the end of 2018, per analysis by DataTrek Research using data from the Investment Company Institute (ICI), as published in Barron's.

Additionally, during the past three years, assets in money market funds have grown by about $1 trillion, according to the Lipper division of Thomson Reuters, as cited by the Journal. Money market fund balances are now at their highest level in about a decade.

The proprietary Cash Rule Indicator developed by BofAML is the contrarian forecasting tool that Jared Woodard references. It flashes a buy signal for stocks when cash balances held by investors rise above their long-term averages, and it has been a bullish indicator during the last 20 months.

Meanwhile, in the October release of the monthly Global Fund Manager Survey conducted by BofAML, leading investment managers around the world indicated that cash is their most overweight position relative to history. Their average cash balance equaled 5% of their portfolios, compared to an average of 4.6% during the past 10 years.

A survey of 4,600 wealthy entrepreneurs and investors by UBS Global Wealth Management yielded similar results. More than 33% of respondents said that they increased their cash balances in Q3 2019, mainly in response to heightened concerns about trade. In the aggregate, respondents increased their cash allocation from 26% to 27% during the quarter, far above what UBS recommends. Nonetheless, a growing number of respondents expressed increased optimism about the global economy and the stock market, suggesting that their high cash balances eventually might be rotated into equities.

On the other hand, Goldman Sachs estimates that, in the aggregate, investors have about 12% of their portfolios in cash, and that this is low by historic standards, in only the 5th percentile since 1990. Meanwhile, Goldman also calculates that the overall allocation to stocks is 44%, historically high at the 81st percentile for the same time period.

Looking Ahead

“The sudden increase in money market fund assets this year bears watching since it is a sign of investor risk aversion," Nicolas Colas, co-founder of DataTrek Research wrote last month, as quoted by MW. “Some market commentators are calling this ‘dry powder’ for a late-year market rally. Perhaps, but we’ll have to get through upcoming US-China trade talks and the Fed’s October 30 meeting first,” he noted.

The Fed voted to cut the federal funds rate by another 25 basis points. This was expected, and the S&P 500 is up by about 1% since then.

"Without the tailwind of lower rates as the Fed pauses, future [stock market] gains will depend on positive earnings improvements, which in turn are reliant on economic growth," observes Lisa Shalett, chief investment officer (CIO) of Morgan Stanley Wealth Management in the current GIC Weekly from their Global Investment Committee. However, she finds profit growth to be "lackluster" and current economic data to be unimpressive.