Investors' Rush To Cash Signals More Big Declines Ahead

Investors are increasing their cash balances at the fastest pace since the financial crisis year of 2008, and that may be an ominous signal for the stock market. In the fourth quarter of 2018, the balances in money market funds jumped by $190 billion, while an additional $2 billion was added during the first 17 days of January 2019, per Lipper Research, a division of Thomson Reuters. Based on history since 1952, the S&P 500 Index (SPX) has tended to fall in years when cash allocations rise, Goldman Sachs finds. "Cash is a great short-term way to mitigate volatility," observes Matthew McLennan, a portfolio manager with First Eagle Asset Management, in remarks to The Wall Street Journal, which also cited the data above.

Investors Rush To Cash

  • $2 billion moved to money market funds (YTD through Jan. 17)
  • $190 billion moved to money market funds, 4th quarter 2018

Source: Lipper Research, as reported by The Wall Street Journal

Significance For Investors

Cash balances fell steadily in the years after the 2008 financial crisis, the result of policy initiatives by the Federal Reserve that pushed interest rates down to historic lows. These initiatives included cuts in the federal funds rate and a massive program of bond purchases that came to be known as quantitative easing (QE).

As the economy has recovered and as a reversal in Fed policy has gotten underway, interest rates moved upward. As a result, cash has become a competitive investment once again. Indeed, cash was among the best-performing asset classes of 2018, beating stocks and bonds alike, per an earlier report in the Journal.

While money market funds were enjoying a brisk increase in asset balances, nearly $100 billion was withdrawn from equity mutual funds in the fourth quarter of 2018, the Journal adds. This is one indication of plunging liquidity in the stock market, which may be raising the odds of a new financial crisis, as Deutsche Bank warns in a recent report.

Meanwhile, Goldman says that investors' dash from equities to cash may increase stock market volatility. They also note that rising cash balances can be a leading indicator of a looming recession, finding that cash holdings historically rise continuously for 12 to 15 months prior to the start of an economic downturn.

Despite the recent uptick in cash holdings, another report from Goldman observes that they are still at 30-year lows. While this report also concludes that "recession fears are overdone," and offers a generally bullish outlook for stocks in 2019, it nonetheless recommends that investors increase their cash holdings as a precautionary measure.

Looking Ahead

Given the uncertainties surrounding both the markets and the general economy, increasing cash may be a wise move even for bullish investors. Indeed, cash balances represent perhaps the cheapest and least complicated hedge available for many portfolios.

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