Is it Time to Jump Back into the Market?

Tuesday, Fidelity Investments sent information to me and perhaps millions (or at least hundreds of thousands) of other people like me who have retirement accounts with their firm in what was clearly an attempt to compel squeamish stock investors to get back in the market while the gettin's good.

In a piece titled The Perils of Herding to Cash, they make the case that a high percentage of money market holdings to overall fund holdings is an indication that it's a good time to buy stocks, presenting the blurry chart you see further below as prime evidence.

The stock market tumbled more than 50% since its peak in 2007, causing many investors to flee to cash. At the end of 2008, the percentage of all mutual fund assets invested in money market funds (37%) stood at its highest level on record, surpassing the previous peak during the bear market of 2002 (34%).

Now, the first thing that should come to mind when you hear about a percentage change such as this, where there are two moving parts - cash and non-cash holdings - is that statistics can be very misleading.

A change in one can dramatically affect the composition of the whole and, given the magnitude of the change we've seen over the last year in the bread-and-butter offerings from big retirement companies like Fidelity - big U.S. stock funds - a rapidly changing percentage of assets held as cash may not be what it appears.

[Note: If you already know where this is heading, you probably also already understand that this is akin to having forgotten to rebalance your investment portfolio and letting last years market crash take care of that job for you.]

Here's the chart, along with the rest of the research note.

S&P 500 - Money Market Assets
Source: Lexis Nexis, Strategic Insight, FMRCo (MARE) as of 12/31/2008.

Fleeing to cash during a bear market reduces one's exposure to stocks when they are at historically lower prices. Back in October 2002, although a new bull market had begun, investors kept an above average level of cash until February '04 -- meaning in the aggregate, investors overallocated to cash during a 15-month period when stocks rose more than 30%.1 As a result, some investors who kept long-term capital tied up in cash likely missed out on big gains in the early stages of a rebound.

Bottom line: Ineffective market timing can be costly
Historically, many investors overcome with fear have increased cash positions during bear markets but have been slow to reallocate to stocks in the early stages of a new bull market. This sell-low, buy-high behavior is a suboptimal strategy, and can cause investors to end up with returns that are worse than the market's average performance.

Perhaps just owning U.S. stocks has been the more fundamental suboptimal strategy...

Obviously, the chart and the words make a compelling case for what the Fidelity research team thinks investors should be doing right now, but, when you look a little deeper, it gets much more interesting and greatly lessens the importance of the argument being made.

Consider the following, based on the two data points cited above in the chart below - the market peak in 2007 (indicated in red) and the end of 2008 when the cash held totaled 37 percent (indicated in violet).
If you had $100,000 invested exclusively in cash and an S&P500 index fund in May of 2007 in the ratios shown above, you'd have $80,000 in stocks and $20,000 in cash.

Fast forward to late-2008 and notice that the cash percentage has risen to 37 percent as the S&P500 has dropped some 42 percent.

So, the question is, "How much of the change in the cash percentage was attributable to the lesser value of stocks and how much had to do with people "herding" into cash?"

Well, that $80,000 in stocks is now worth just under $47,000 and, assuming a modest return on the $20,000 in cash brings that to around $21,000.

This leads to the conclusion that, without doing any "herding" at all (i.e., no stock sales), the cash as a percentage of overall assets has moved from 20 percent to 31 percent!

Assuming no inflows or outflows to simplify this entire discussion, it turns out that about two-thirds in the change to the bottom portion of that chart - from May of 2007 to late-2008 - was due to declining stock prices, not people panicking.

While this may have been unintentional, it does raise serious questions about their motives.

Anyone who did hit the sell button over the last year must surely look at that chart and see themselves in that rapidly rising green section at the bottom and wish to become part of the future rise of the orange curve at the top.

But, as it turns out, that green area isn't really what it appears to be.

Comments

[Larry House:]

Interesting analysis. Advice is everywhere. It is nice to know what is four feet under the surface before one jumps in.

Mar 25 05:09 PM

[Speedspirit:]

This was a dead cat bounce. Now its a sucker rally. The bottom can only be in when all the bad news has been declared. Right now anyway you slice it the truth hasnt been disclosed. The magnitude of this situation cannot be cleared up this quickly. By just the amount of selfishness and greed in the system this proposal cant be the solution yet. Since when has Ben Bernake been right? And Geithner wants to return to Wall Street when his term is over. He might make different decisions if he had thoughts of running for President. And Saunders got kicked out of Harvard for anti social behavior. But with this crisis they have all found God and are acting on his behalf.Please.Time to buy land and wait this out.

Mar 25 05:16 PM

[market ace:]

You are right on point, but to clarify you should be buying FARM land not just land.


On Mar 25 05:16 PM Speedspirit wrote:

> This was a dead cat bounce. Now its a sucker rally. The bottom can
> only be in when all the bad news has been declared. Right now anyway
> you slice it the truth hasnt been disclosed. The magnitude of this
> situation cannot be cleared up this quickly. By just the amount of
> selfishness and greed in the system this proposal cant be the solution
> yet. Since when has Ben Bernake been right? And Geithner wants to
> return to Wall Street when his term is over. He might make different
> decisions if he had thoughts of running for President. And Saunders
> got kicked out of Harvard for anti social behavior. But with this
> crisis they have all found God and are acting on his behalf.Please.Time
> to buy land and wait this out.

Mar 25 05:30 PM

[mac.barron:]

This is a great article; this kind of input is exactly why I read SeekingAlpha. Indeed, Mr. Iacono is correct: "The green area isn't really what it appears to be."

If you are thinking that the rally is the end of the bear market and a recovery is on the way you may be right, but consider the impact of the biggest economic gamble since the series of gambles on unqualified borrowers and credit default swaps that got us into this mess.

It is a challenge to find anyone who supports the TARP 3.0 plan outside the Administration and the banking sector; even the President has described it in less than glowing terms. And why would he be pleased with it? In essence the government is spending several trillion dollars to fund the biggest moral hazard in history: to reward those who betrayed their responsibilities, who were most reckless, who were most greedy and who exhibited the least common sense. Moreover, the dollars that we have created out of thin air for this ignoble purpose will not do anything useful like help to build up a decent manufacturing base in the U.S. or make our economy more sustainable. All that the citizens will get is a huge defect, significant inflation and a scot free escape for those responsible for the crash.

In the end there is no way to hold back the tide. Things will come crashing down again because you can't borrow your way out of the mess that borrowing caused in the first place. Fidelity can play games with charts and figures but the reality cannot be avoided. If you get stuck in this market when it snaps back you will wonder how you missed the writing on the wall.

Disclosure: no short positions, no gain from the loss of value in the U.S. markets. Long: Gold, silver and foreign equities, mainly in the energy sector.

Mar 25 05:37 PM

[F. Bradeen:]

You have answered a problem I have had with cash versus stock positions. That is, in a relatively closed system like the stock market there is NO CHANGE in either the amount of cash or the amount of stock in circulation. Only the price of the stock changes.

For example, at the top of the market if I sell 100 shares priced at $100, I get $10,000 from the buyer and he gets 100 shares. Now fast forward one year and the price is now $50 per share. I decide to buy back my 100 shares. I give the seller $5,000 and I get 100 shares, but remember, I still have $5,000 left. As you can see there is still 100 shares and $10,000 in the system. The only change is the price of the stock.

Your analysis now shows why the % cash on the sidelines goes up, but the amount of cash remains the same. Thanks for the insight.

Mar 25 05:57 PM

[Harold Goodman:]

Brilliant analysis. It shows that charts can and do lie, especially to the uniformed.

Mar 25 06:57 PM

[Steven Hansen:]

tim, an simple analysis with an obvious conclusion. great work.

investor money in equities will soon compete with Geithner's bank toxic asset purchase / loan schemes. this will be interesting to watch were the money flows.

Mar 25 08:34 PM

[RiskReturnO...:]

The second part of that analysis shows that those who buy 1 year before the bottom and 1 year after the bottom would both get 10%+ annualized gains the subsequent 10 year period. Clearly, Fidelity is trying very hard to get people back into the stock market. I would take their advice and be up to 1 year late, and still get decent long term returns.

Mar 25 09:25 PM

[sundrenched:]

Suckers rally! It's unconscionable for professionals to advise people going back in here. Meanwhile the shorts are reloading their guns.

Maybe instead of "taking candy from a baby", it should be "like taking the 401k off of a pensioner".

Mar 25 10:31 PM

[wise:]

good work. A clear point.

Mar 25 11:02 PM

[zermux:]

Question: Is it time to jump back in the market?
Answer: No
Question2: Awww, but I want to - i would hate to miss out on the bounce
Answer2: Stay in Cash. A bottom is not real until it is a double bottom or a reverse head and shoulders. wait for the retest - if it fails then stay in cash - if it holds then buy in - Simple.

Mar 26 12:20 AM

[Paul Price:]

Actually, the time to get back in was around March 9th rather than now after a better than 20% market move.

Still, there are many bargains to be had and little competition from fixed income rates that are artificially low due to Fed actions.

Mar 26 08:18 AM

[mrresponsible:]

My Fidelity m-a-n-a-g-e-d account has essentially redistributed my 60% stocks/40% bonds/fixed account to put more of the safer (bond/fixed) funds into stocks - rather high risk method if the market keeps going down! - but rewarding if market recovers - really they are timing the market, aren't they? So, over the long haul, it will probably perform better than if I was emotionally managing the account. I also have an account at Lussenheide Captial Management, Inc. where they time it based on the 100 day NASDAQ moving average. Long-term is the key here again but reasonably satisfied.

Mar 26 11:05 AM

[Still Renting:]

How's that commercial RE bottom, which we are not even close to, gonna impact this? I agree that until the bad news is vetted, calling a bottom is a fools game.

A few major shopping mall bankruptcies/closures cannot help the market.

This is going to be an interesting spring/summer.

Mar 26 02:20 PM

[Teutonic Kn...:]

Mr. Iacono,

Thanks for another great insightful article. My short answer to your question is No.

Reason: simple, just my hunch...my inside tells me this correction is still far from being done to removing all those "excesses" of the past decades.

teutonic

Mar 26 11:19 PM