'Cash on the Sidelines' Should Be 'Investors on the Sidelines'

I had gotten some intense reactions from my previous post with regards to cash on the sidelines (in the form of money market mutual fund investments) flowing to bonds and not to equities, thus equities are not likely to fall as hard given the lack of money flowing to them. From Seeking Alpha, logical thought said this:

"One can wonder how equities can drop in that fashion when there aren't enough long positions to liquidate in the first place."

You're kidding, right? This statement makes absolutely no sense whatsoever, assuming that there are approximately the same number of shares in existence now as there were during the March lows (thereby making for the same number of "long positions"). In fact, I suspect that there may actually be MORE shares out there (and thus more "long positions"), as there have been few if any buy-backs while there has been lots of equity issuance. Meanwhile, what HAVE declined greatly are the short positions, so you can kiss that cushion goodbye.

There have also been harsh reactions against the "cash on the sidelines" argument in these posts:
"What About All That Cash On The Sidelines?"
"The Fallacy of Cash On The Sidelines"

All these arguments against cash on the sidelines and the lack of flows into equities being a bullish indicator suffer from having too narrow a view on the matter, in fact they can be considered "square" or too "literal" or "simplistic". Other bullish proponents, including myself, were not referring to the actual number of shares out there. Those who oppose the "cash on the sidelines" argument are in fact correct in their obvious assessment that for every seller, there is a buyer, thus there is no inflow into or outflow out of equities. The number of shares long held by investors are indeed constant (unless there are buybacks or share issuance). They thus say that this has no effect whatsoever on additional flows that may push equities up further. It's pretty simple and easy to fall for this argument actually.

Here is the less "literal" and more truthful view on the matter. Before the market capitulated last March, majority of people were panic selling on the way down. Only a brave few tried to catch this "falling knife", and some who tried to do this stunt too early also sold shares further down. But there were a smart few who were able to buy the bulk of their positions at or near the very bottom, and these individuals or institutions were few and far between among those who were liquidating or going short. So in short, a few number of individuals or institutions absorbed the selling of a majority number of individuals or institutions. Most investors had little or no positions, while a rare minority had almost 100% positions in equities (since they had to absorb everyone else' positions). There is in fact, no outflow out of equities in a theoretical sense. But what occurred was an "outflow of investors" instead.

If shares are held only by a few entities and the majority of the public are mostly out of stocks, and the former are not selling (since they just bought so much), what do you have? You have short supply of shares, and new buyers would have no choice but to bid shares up since those who bought the majority of shares are just holding. So naturally, stocks go up without volume, and the move can be massive. We just witnessed this the past six months with the S&P 500 going up by as much as 60%.

Now if you were one of the lucky individuals or institutions who saw that shares were pricing in a depression scenario and had the foresight to see that only a less-bearish recession was taking place, and you're almost 100% exposed to equities, how do you exit your positions eventually? You sell slowly ON THE WAY UP and wait till there is ENOUGH OF A BID on the market to dump the rest of the shares (if you ever plan to). You cannot dump your massive positions in one go if there is no bid volume in the market. This is exactly what is happening now given the many skeptics. So you can say that despite the market going up this much, the contrarian side is still the bullish view.

By the time you get the bid under the market for you to dump the long positions you accumulated near the low, guess what... by this time the recession is already over and the consensus already agrees with it, that's why you get the demand for shares. It's a confirmed bull market by this time. People are always like this, they need the concrete and tangible data to come out before they commit to putting money to work in equities again.

This is precisely what I mean by "one can wonder how equities can drop in that fashion when there aren't enough long positions to liquidate in the first place". I didn't mean it in a literal sense. It's not that there are not enough shares out there, but the smart money who accumulated near the bottom will keep the supply of shares and only unload it when the demand is there.

Unless they decide to sell, supply will remain restricted and equities have more room to run... until we get another "inflow of investors" into equities again. Based on the chart below, we haven't got this inflow into equities yet. I think they should rename "cash on the sidelines" to "investors on the sidelines" to avoid more confusion.

Disclosure: None

Comments

[logicalthought:]

>>...the smart money who accumulated near the bottom will keep the supply of shares and only unload it when the demand is there.<<

The alternative scenario is that "the smart money" (most of which is quite bearish on the economic fundamentals) will get tired of waiting for "the dumb money" to take those shares off their hands, and will instead dump their stocks before the music stops playing again in order to preserve whatever profits they have left.

Sep 27 08:31 AM

[Terence Chan:]

It's a cycle actually. Even if the smart money dumps their positions there will be a new group of buyers though still limited in number given the bearish sentiment prevailing in the market. This new group of buyers can keep the shares for a while longer, and new groups of buyers emerge at higher levels as the economic recovery doesn't falter. Eventually the groups of buyers will reach a critical mass that will further propel stocks. Data shows we don't have a bubble in stocks. People aren't overleveraged in stocks out of fear, and are in fact underinvested. Just look at all the bearish comments in Seeking Alpha. You cannot have a crash when people are underinvested. Also, think about this... will smart money buy that much shares if they will just flip it? They're smart enough to now that they aren't nimble enough to flip that much shares, so most likely they are buy and hold and don't believe in any armageddon scenario.


On Sep 27 08:31 AM logicalthought wrote:

> >>...the smart money who accumulated near the bottom will keep the
> supply of shares and only unload it when the demand is there.<<<br/>
>
> The alternative scenario is that "the smart money" (most of which
> is quite bearish on the economic fundamentals) will get tired of
> waiting for "the dumb money" to take those shares off their hands,
> and will instead dump their stocks before the music stops playing
> again in order to preserve whatever profits they have left.

Sep 27 09:35 AM

[Terence Chan:]

People also have to understand that the stock market can't be all fundamentals. One has to understand demand and supply and also sentiment (when to be contrarian). Fundamentals can be wrong since it is based on subjective assessment. Demand and supply of stock are actual and cannot be disputed. Stock prices are also "real" and it is better to let the market tell you where it is going, not you telling the market where to go. You are not in control of the market. This is not to say fundamentals are useless, it is in fact necessary. But it's not the only analysis. You have to see the bigger picture and confirm fundamentals with technicals. Technicals right now are showing a different picture compared to what you see in the actual economy. Some people dismiss technicals and other analysis on supply and demand just because they do not understand this aspect of market analysis and don't want to learn something new. That's being rigid and closed minded.


On Sep 27 08:31 AM logicalthought wrote:

> >>...the smart money who accumulated near the bottom will keep the
> supply of shares and only unload it when the demand is there.<<<br/>
>
> The alternative scenario is that "the smart money" (most of which
> is quite bearish on the economic fundamentals) will get tired of
> waiting for "the dumb money" to take those shares off their hands,
> and will instead dump their stocks before the music stops playing
> again in order to preserve whatever profits they have left.

Sep 27 09:42 AM

[logicalthought:]

>>People also have to understand that the stock market can't be all fundamentals.<<

Of course not, but only in the short run. Otherwise, how would you explain where the Nasdaq was in January of 2000, or the S&P in the summer of 2007? I understand and use technicals all the time, for entry and exit points for my fundamentally-based positions. But if you're so highly technically-oriented, surely you'll note the implications of the fact that the volume on almost this entire ride up has been far less than it was on the way down.

Sep 27 05:27 PM

[Terence Chan:]

Volume always comes at peaks. If there's no volume, it might correct short-term, but it won't crash:)


On Sep 27 05:27 PM logicalthought wrote:

> >>People also have to understand that the stock market can't be all
> fundamentals.<<
>
> Of course not, but only in the short run. Otherwise, how would you
> explain where the Nasdaq was in January of 2000, or the S&amp;P in
> the summer of 2007? I understand and use technicals all the time,
> for entry and exit points for my fundamentally-based positions. But
> if you're so highly technically-oriented, surely you'll note the
> implications of the fact that the volume on almost this entire ride
> up has been far less than it was on the way down.

Sep 27 06:19 PM

[logicalthought:]

That's absolutely not necessarily true. Assuming that SPY volume is a good proxy for overall market volume, look at how light it was in late September and into October of 2007 when the SPY/S&P hit the all-time highs, and then look at how much stronger it was in the July-August plunge that preceded that and then the big plunges that happened after.


On Sep 27 06:19 PM Terence Chan wrote:

> Volume always comes at peaks. If there's no volume, it might correct
> short-term, but it won't crash:)

Sep 27 09:29 PM

[Terence Chan:]

hehe. expand your chart to 3 years. the light volume was before march 2007. After that volume picked up so there is sign of distribution. compare it to the period before march 2007. There was volume at the top. but of course nobody gets to sell at the top, so a lot of volume also came out thereafter. right now, there is no signs of distribution, so no top for the market:)


On Sep 27 09:29 PM logicalthought wrote:

> That's absolutely not necessarily true. Assuming that SPY volume
> is a good proxy for overall market volume, look at how light it was
> in late September and into October of 2007 when the SPY/S&amp;P hit
> the all-time highs, and then look at how much stronger it was in
> the July-August plunge that preceded that and then the big plunges
> that happened after.

Sep 27 10:52 PM

[logicalthought:]

I just pulled up a five-year daily chart. When the volume was light, the market was trending up very gently: On 10/1/2004 the SPY was at 113, and on 2/21/2007 (just before the volume increased drastically) it was at 146, equaling a 29% move over 29 months. Compare that to this 60% up-move over seven months, where the volume has been much higher than it was on that earlier move. So by your definition, why is this NOT "distribution"?

Personally, that's much less meaningful to me than the concept of RELATIVE volume when comparing two recent opposite trends, and that's why the light volume on this uptrend makes it less credible compared to the big multi-month volume on the downtrend. I'm not "calling the top" right here, but I'm 99% sure that we're within 10% of it.


On Sep 27 10:52 PM Terence Chan wrote:

> hehe. expand your chart to 3 years. the light volume was before
> march 2007. After that volume picked up so there is sign of distribution.
> compare it to the period before march 2007. There was volume at
> the top. but of course nobody gets to sell at the top, so a lot
> of volume also came out thereafter. right now, there is no signs
> of distribution, so no top for the market:)

Sep 28 07:44 AM

[Gtarras:]

oh, please, so much cyber ink. just made me even more confused. just look at this chart with history of "cash on the sidelines:

www.ritholtz.com/blog/.../

should clear it all up.

Sep 28 10:57 AM