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Monday December 4, 10:54 am Eastern Time

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Rising Cash Levels a Bad Sign in Bearish Times

Reflecting investors' skittishness about the market, bucks now make up 6% of stock mutual funds' holdings.

By David A. Gaffen
Staff Reporter

Over the last several years, a rise in cash levels has been viewed positively, because it represented money ready to be funneled into the continuously rising stock market. Cash was, in fact, king.

But what happens when cash levels rise in a veritable bear market? Well, as Martha Stewart might say, it's not necessarily a good thing.

The Investment Company Institute said Wednesday that cash as a percentage of stock mutual funds was 6% in October, up from 5.3% in September. That's the highest since September 1998.

What's potentially disconcerting is that the 6% level is still low when examined on a historical basis. From January 1990 through this October, stock mutual funds held an average cash position of 7.4%. It's been consistently below 5% since 1998, but some strategists see the possibility of a reversion to something closer to the historical norm.

"If you're in a bull market, and cash is building up, that's bullish," says Richard Dickson, technical analyst at Scott & Stringfellow in Richmond, Va. "But in this market, that's neutral at best. It's not a sign all this money has to come back into the market."

Year-in, year-out 20% gains in stocks prompted portfolio managers to become more aggressive in buying stocks, and for individuals to put more of their money into stocks. Investment managers didn't have to sell shares for redemptions -- people wanted to stay invested. And with people staying invested, the meager level of redemptions could be handled with cash or by a few sales of stocks that had gone through the roof.

This frenzy continued, with the level of cash in mutual funds declining every month, ultimately hitting 4.1% this March, the month the market began to collapse. At that point, managers were hardly bothering with cash at all; it was a drain on a portfolio's performance.

Since March, that's all been changing. At times, cash levels have jumped sharply at specific moments, only to return to the earlier pattern when crisis was averted. In July 1998, cash made up 5.2% of stock mutual fund assets; it jumped to 6% in August and 6.3% in September as a result of the Asian crisis, but fell back. By contrast, cash accounted for 5% of assets in October last year, when Y2K was on everyone's mind; By last December, with most people believing it was a nonissue, cash was down to 4.3%.

"It's that virtuous cycle," says Dickson. "You put your money in, shares go up, and it attracts more money."

Dickson, however, believes that "this could be a death spiral. If fund managers get hit with redemptions, they've got to sell stock, which means mutual fund shares are going down, and it brings more redemptions, and you get the picture."

Right now, investors aren't facing a shock to the financial system. People are thinking about the possibility of a broader economic slowdown, resulting in diminished purchasing power for individuals and fund managers. Consumers have become more protective of their finances, and portfolio managers, looking at the charts and anticipating a sharp decline in corporate profits, don't see much incentive to put money into the market.

"Typically, that's what bear markets are about," says Paul Kasriel, chief U.S. economist at Northern Trust . "You raise cash and continue to raise cash for an extended period of time."

Redemptions could enhance that spiral. With greater attention paid to quarterly performance measures and the day-to-day workings of the market, investors have pulled money out of the market. They're likely to keep it up. Funds are going to continue to contend with redemptions.

It'll take another few months of data to show whether an increase in cash levels is a temporary fad. But with the anticipation that the economy is going to continue to slow, and fund managers staring at a Nasdaq Composite Index worth about half of what it was nearly seven months ago, putting a few greenbacks in the safe doesn't seem like a bad strategy.

-- (M@rket.trends), December 05, 2000