A reader asks:
I have a stock market theory. The large amount of cash in money markets, HYSAs, etc. means that a “down” day/days for the stock market will quickly be reversed by buying the dip. And this will continue until cash balances drop significantly. Thoughts?
There is a lot of cash sitting in money market funds right now:
That’s $6.3 trillion, which is nearly double the amount that was in these funds pre-pandemic.
It makes sense. The Fed jacked up short-term interest rates. You can get in excess of 5% in these funds. Long-duration bonds carry much higher interest rate risk and got crushed when rates rose. These are short-term debt instruments that don’t go down in value on a nominal basis.
Money market funds have been a win-win for investors who needed some mix of yield, volatility protection and liquidity these past few years.
But what happens when the Fed starts cutting rates?
Yields on money market funds will fall. It’s possible the Fed could cut rates rather quickly. Those 5% yields could turn into 2-3% yields in a relatively short period of time if inflation keeps falling, the economy slows even further or some combination of the two.
It’s a fair question to ask whether this cash on the sidelines will provide a buffer to falling stock prices.
Let’s start with some quantitative analysis before going into the more qualitative aspects of this theory.
The Federal Reserve has quarterly data on money market assets going back to the mid-1970s. I looked at the change in quarterly money market assets and the corresponding quarterly return on the S&P 500.
It was hard to find much of a strong relationship one way or another:
To test this theory, I looked at the returns in the down quarters for
