'Money on the Sidelines' Is a Myth

by: Graham Summers

Throughout the last six months, I’ve heard numerous sources contend that should stocks roll over, “the money on the sidelines” would flow into the market and push it higher.

The “money on the sidelines” theory is a great… theory. But it is not a fact. To understand what I mean, you need to know about Money Market Funds.

Money Market Funds are essentially glorified bank accounts where institutional and retail investors park their cash when they’re not investing in stocks, bonds, commodities, or other investments. This is the “money on the sidelines”.

According to the ICI Money Market Fund data for September 17 2009, there is currently $3.48 trillion sitting in money market funds today. The last time this little money was sitting “on the sidelines” was back in the autumn of 2007, a time when everyone believed stocks would never fall (didn’t someone write a “Dow at 30,000” book?), no investment banks had collapsed, Fannie (FNM)/Freddie (FRE) were still “privately” held, AIG still existed... you get the picture.

Another component of the “money on the sidelines” theory consists of mutual funds flows. If more people are putting their money into mutual funds, this in turn means there are more available assets to invest in the stock market (mutual funds often have to keep most if not all of their assets invested at a time).

Well, the latest flow of mutual funds report shows that money has not flowed into stock-based mutual funds since August 12. In fact, $7 billion flowed out of mutual funds in the last month. So much for the idea that retail investors are pouring back into the market.

In simple terms, the money on the sidelines theory is a myth, plain and simple. If you don’t believe me, have a look at the volume on the S&P 500. After all, if there were indeed a ton of money on the sidelines waiting to invest, shouldn’t volume swell soon after the market dips as investors pile in?

As you can see, quite the opposite is occurring. Volume actually swells during corrections and then tapers off dramatically once stocks start rallying. In fact, when you compare “down” days to “up” days in terms of volume, it’s clear most investors are waiting to sell the market since volume always explodes when the market dives.

The below chart from Zero Hedge shows the volume differential for the day that the Federal Reserve released its FOMC minutes. Have a look at what happened to volume once the market started diving.

In simple terms, the “money on the sidelines” view is a load of baloney. Yeah, sure, stocks could go higher as more money flows into the stock market, but with stocks already up 50% since March, the S&P 500 priced at a P/E of 100+ (or 26 if you want to use operating earnings), corporate insiders unloading shares in record numbers, more companies cutting dividends than at any time in history, and the Federal Reserve starting to cut back on its interventions, one has to ask one’s self - just who wants to buy into this rally?

Last one to the party is only going to get stuck cleaning up.