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Cash Glut Could Take Markets on a Ride

By Eric Martin and Michael Tsang
Bloomberg News
Sunday, January 4, 2009

There's more cash available to buy shares than at any time in almost two decades, a sign to some of the most successful investors that equities will rebound after the worst year for U.S. stocks since the Great Depression.

The $8.85 trillion held in cash, bank deposits and money-market funds is equal to 74 percent of the market value of U.S. companies, the highest ratio since 1990, according to Federal Reserve data compiled by Leuthold Group and Bloomberg News.

Leuthold, Invesco Aim Advisors, Hennessy Advisors and BlackRock, which together oversee almost $1.7 trillion, say that's a sign the Standard & Poor's 500-stock index will rise after $1 trillion in credit losses sent the benchmark index for American equities to the largest annual drop since 1931. The eight previous times that cash peaked compared with the market's capitalization the S&P 500 rose an average 24 percent in six months, according to data compiled by Bloomberg News.

"There is a store of cash out there that is able to take the market higher," said Eric Bjorgen, who helps oversee $3.4 billion at Leuthold in Minneapolis. "The same dollar you had last year buys you twice as much S&P 500 as it did a year ago."

Leuthold Group, whose Grizzly Short Fund returned 83 percent in 2008 thanks to bets against equities, said in its December bulletin to investors that stocks offer "one of the great buying opportunities of your lifetime."

The ratio of cash on hand to U.S. market capitalization jumped 86 percent in the first 11 months of the year, the biggest increase since the Fed began keeping records in 1959, as the United States, Europe and Japan fell into the first simultaneous recessions since World War II.

So-called money of zero maturity, the central bank's measure of U.S. assets available for immediate spending, is mostly held by households, according to Richard G. Anderson, an economist at the Federal Reserve Bank of St. Louis.

"What the cash pile on the sidelines represents is dry powder," said Fritz Meyer, senior market strategist at Invesco Aim, which manages about $358 billion. The firm's $1.17 billion Aim Diversified Dividend Fund beat 96 percent of its competitors this year, and the $3.95 billion Aim Charter Fund topped 93 percent of similar mutual funds.

"Recovery in the second half of the year will probably play out," Meyer added.

Any recovery will depend on a rebound in corporate profits and the economy after $30 trillion was wiped out from world equities this year, according to Frederic Dickson, chief market strategist at D.A. Davidson & Co. in Lake Oswego, Ore.

Jobless claims reached a 26-year high last week. A 13 percent slump in the median home resale price in November from a year earlier was likely the largest since the 1930s, the National Association of Realtors said last week, damping speculation that the housing market is close to a bottom.

Analysts estimate profits at S&P 500 companies will shrink 10.3 percent in the first three months of 2009 and 5.8 percent in the second quarter, bringing the stretch of earnings declines to a record eight quarters, Bloomberg News data show. Gross domestic product will contract in the first half of the year before growth resumes in the third quarter, according to a Bloomberg News survey of economists.

"The fuel supply is there, but people have to have a reason to use it," said Dickson, who helps oversee about $19 billion. "The Fed fired the shot out of the biggest cannon they know. Now the question is, will it hit the right mark?"

This year's slump has left S&P 500 companies valued at an average of 12.6 times operating profit, the cheapest since at least 1998, monthly data compiled by Bloomberg News show.

Cash in interest-bearing checking accounts at U.S. banks earns less than 0.1 percent annually, minus inflation, according to national data compiled by Bankrate.com. Ten-year Treasury notes yield 1.03 percent after adjusting for the cost of living, and yields fell to the lowest level on record this month.

Investor Seth Klarman's Baupost Group, which held 40 percent to 50 percent of the hedge-fund firm's more than $14 billion in cash, reduced its hoard by half to take advantage of falling asset prices, according to the December issue of Harvard Business School's Alumni Bulletin.

Klarman, who seeks shares of companies trading at discounts to measures such as assets and cash flow, was the lead editor for the sixth edition of Benjamin Graham and David L. Dodd's "Security Analysis," which laid out the principles of value investing followed by billionaire Warren Buffett.

Klarman has generated an annual compound return of 20 percent in the past 26 years, the Bulletin said. He declined to comment in an e-mailed response to Bloomberg News.

Cash holdings peaked one month before equities began to recover during the two longest recessions since World War II. In July 1982, money of zero maturity as a percentage of the U.S. stock market's value rose to 95 percent before that 20-month bear market ended and the S&P 500 began a six-month, 36 percent advance, according to data compiled by Bloomberg News.

Cash on hand reached $604.5 billion in September 1974, representing a record 1.21 times U.S. stock capitalization. That preceded a 31 percent gain in equities between October 1974 and March 1975, Bloomberg News data show.

"If history tends to repeat itself, we're in the exact same scenario," said Neil Hennessy, who oversees $650 million as president of Hennessy Advisors in Novato, Calif. "Once the money starts to come back into the market, buying is going to beget more buying. People don't want to be left behind."

Hennessy's Focus 30 Fund beat 96 percent of its peers this year.

The last time cash accounted for a larger proportion of market value was 1990. The ratio peaked at 75 percent in October of that year, after the savings and loan industry collapsed, Drexel Burnham Lambert was forced into bankruptcy and the United States fell into a recession. The S&P 500 rallied 23 percent in six months and almost 30 percent in a year.

Robert Doll, the chief investment officer of global equities at BlackRock, has been buying stocks anticipating that the S&P 500 might rise as much as 20 percent next year. The firm oversees $1.3 trillion.

"It's a mountain of cash," Doll said on Bloomberg Radio. "Somebody's just got to find the match and light it."

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