Outside the Box: Tracking Cash Positions in the Market
March 26, 2008
When the Federal Reserve forces interest rates down, equity prices are usually poised to increase. Cheaply borrowed money and money from low-yield investments will quickly find their way into brokerage accounts and those account balances can tell you not only how much money is available for stock purchasing, but also what investor psychology thinks of the future. To get a handle on this psychology market, technicians monitor four key cash flow indicators very closely.
Changes in the totals assets of money-market funds, reported in the Market Lab’s Federal Reserve Data Bank, tells the analyst which direction the money is flowing. For instance, high interest rates on short-term cash equivalents like certificates of deposit and T-bills attract safety-conscious investors. Those investors will tend to put less money in the stock market. That means lower equity prices. But that only sets the stage for a bull market when rates decline and investors scramble to get out of money funds and into stocks.
The reverse situation, low money-market assets and low rates, means that money will tend to leave the stock market when interest rates turn up.
Using money-market-fund asset balances is tricky, which is true of most all cash indicators. In the short run, when the money funds are abundant, stocks will be depressed. However, in the longer run, high money-fund asset balances provide a contrary clue of a future bull market. Remember, when cash leaves the money funds and heads toward stocks, a lot of it goes into mutual funds. So when money-fund balances turn down and mutual fund assets begin to head up, market increases can soon be expected.
The Mutual Fund Liquid Assets Ratio, reported in the Mutual Fund Monthly Indicators, tells the analyst what’s going on inside mutual funds themselves in terms of how much free cash they have in relation to stocks and bonds. When cash positions are high, because new investors are adding money or because stocks are liquidated, available purchasing power and bullish potential are both great. The opposite is true when cash is down and buying power low.
The Mutual Fund Liquid Assets Ratio is an indicator that works two ways, when you’re thinking about the long-run aspect of the trend. That’s because fund managers, like investment advisers, are trend followers. As the market heads down, they sell—so at market bottoms, they’ll have very large cash balances. And that’s when as traders we will want to load up and take advantage of the next market upswing.
At the top, mutual funds will be fully invested, with low cash balances, which tell the trader it may be time to cash in. Ratios under 5 percent indicate limited liquidity and too much optimism, which is bearish. But watch for high ratios, more than 11 percent they’re pessimistic and bullish in the long run.
What’s true about the cash in stock mutual funds is also true about the cash in individual brokerage accounts, which you find out about in the Market Lab section on the New York Stock Exchange’s Monthly Statistics. Customer Credit Balances indicates the amount of potential buying power, so low balances are bearish and high cash balances mean more bullish buying power. And because mainstream investors are also trend followers, and more often wrong than right, they’ll draw down their cash just as the market peaks and they should be selling and raising cash.
At bottoms, they’ll have too much cash and too few stocks, which means it’s time for winning timers to get back on the stock bandwagon ahead of the herd. Just as there are two kinds of investors, called winners and losers, there are two kinds of indicators you want to keep up with the smart money and use contrary indicators to go against the herd. The investor can find out if the smart money has started to get on board by looking up Customer Margin Debt; it’s also in the NYSE cash data.
When sophisticated investors are increasing their stock positions by borrowing from their brokers, the market is likely to be headed up. If margin debt is falling, the market is headed the same way. Timers wanting to maximize stock positions ahead of turns in the trend use margin debt data extensively.
The trader can learn something from both the direction of margin debt and its overall size as well. If margin debt gets to twice what it was at the last market bottom, timers will start to cut back. When it gets down to half of what it was at the top, they’ll likely start expanding their credit buying. That way they’ll be in step with the trend even if they miss its exact turning points. The smart money is smart because it wants to make friends with the trend as fast as it can.
The market’s always going to bounce around, and this perpetual fluctuation may mean that there’s never an exactly right time to buy a stock, however, there will always be a time that’s better than another. By learning and using these cash flow indicators you‘ll have gone a long way in improving your market timing capabilities and the profitability of your trading account.
Happy Trading.
Jeff Neal
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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