By David Randall, Saqib Iqbal Ahmed and Lewis Krauskopf
NEW YORK (Reuters) – Investors wondering whether markets can continue their tremendous rally are turning to one important factor that could boost assets: a cash reserve of nearly $6 trillion.
The surge in yields has drawn liquidity into money markets and other short-term instruments as many investors have opted to collect income in ultra-secure vehicles while awaiting the outcome of the Federal Reserve’s battle against the surge in inflation. Total money market fund assets hit a record $5.9 trillion on Dec. 6, according to data from the Investment Company Institute.
The Fed’s unexpected dovish turn Wednesday may have upended that calculus: If borrowing costs fall in 2024, yields will likely fall along with it. That could push some investors to plow cash into stocks and other risky investments, while others rush to lock in long-term bond returns.
Cash returned an average of 4.5% in the year following the Fed’s last rate hike of a cycle, while U.S. stocks jumped 24.3% and investment-grade debt by 13.6%, according to BlackRock data dating back to 1995.
“We get calls … from clients who have a significant level of cash and realize they need to do something with it,” said Charles Lemonides, portfolio manager at hedge fund ValueWorks LLC. “This is the beginning of a cycle that will begin to feed itself.”
Recent market developments show that the rush to recalibrate portfolios may have already begun. Benchmark 10-year Treasury yields, which move inversely to bond prices, have fallen about 24 basis points since Wednesday’s Fed meeting to 3.9153%, the lowest since late July .
The S&P 500 is up 1.6% since Wednesday’s Fed decision and is less than 2% below a record. The index is up nearly 23% this year.
“If you think the Fed is done with the hike cycle, then it’s time to deploy liquidity because the opportunity is there,” said Flavio Carpenzano, director of fixed income at Capital Group.
Not all of the cash in money market funds may be available in “dry powder” form for investment in stocks and bonds. Some of that money is held by institutions that might otherwise have that money in bank deposits and is needed for cash flow purposes, said Peter Crane, president of Crane Data, which tracks money market funds.
History also shows that most liquidity in money markets tends to remain even when rates fall, said Adam Turnquist, chief technical strategist at LPL Financial.
“I think we might start to see flows out of the money markets and continue that rally, but I don’t think we’re going to see anything to the tune of a trillion dollars or the massive flows that some people might expect.” » said Turnquist.
And even though money market assets are at record highs, their size relative to the S&P 500 is smaller than it has been at past peaks.
Total money market fund assets as a percentage of market capitalization stand at around 15.5%, in line with the long-term median and well below the record high of 64% reached in 2009 in the wake of the global financial crisis.
But for now, investors’ appetite for risk is easy to spot. In the options market, for example, traders reject any protection against a short-term decline in stocks, even if the price of such hedges is historically attractive. The Cboe Volatility Index, which reflects demand for insurance against market fluctuations, fell this month to its pre-pandemic low.
“No one is interested in buying insurance,” said Chris Murphy, co-head of derivative strategy at Susquehanna Financial Group, noting that the low level of defensive positioning leaves the market vulnerable to a sharp reversal in the event of a negative shock. unexpected.
Indeed, the strong rebound in stocks since their October lows has led some investors to be wary of the markets rising too quickly.
“There’s enough money available that it doesn’t take much to drive the markets higher,” said Jason Draho, head of asset allocation for the Americas at UBS Global Wealth Management.
Still, the rapid gains over the past six weeks in both stocks and shares “make you worry a little bit about the future of the markets as a whole,” he said.
(Reporting by David Randall, Saqib Iqbal Ahmed and Lewis Krauskopf; additional reporting by Dhara Ranasinghe; editing by Ira Iosebashvili and Leslie Adler)
