The cash bubble hasn't burst yet
A lot of money has been sitting on the sidelines since last fall's meltdown. But with stocks on a tear lately, will more cash be put to work to fuel long-term gains?
 |
| The Dow, S&P 500 and Nasdaq have all surged over the past month and a half. Still, a healthy chunk of cash is not invested in the market as many are unsure if the rally is for real. |
NEW YORK (CNNMoney.com) -- Investors pulled their money out of the stock market in droves following last fall's credit market collapse. But they may be slowly putting cash back to work now that stocks are in the midst of an explosive rally.
With the S&P 500 up 25% since early March, some investors -- particularly professional money managers -- may feel the need to chase the market's performance or face questions from customers about why they sat out the rally.
Still, a lot of cash continues to sit on the sidelines.
According to figures from ISI Group, the amount of money invested in money market funds and small certificates of deposit (CDs) make up more than 60% of the market's total valuation, as measured by the Wilshire 5000 index. The last time this measure of cash reserves was so high was in 1985.
What's more, 28.5% of all U.S. stock mutual funds have more than 5% of their assets in cash, according to fund tracker Morningstar. Typically, any fund with more than 5% in cash is considered to be not fully invested in the market.
In addition, more than 100 mutual funds are being ultra-conservative: they have more than 25% of their assets in cash.
So what's going to happen next? Will this cash remain in relatively low-return, but less risky types of investments? Or will the "cash bubble" burst as investors once again embrace stocks?
Some investing experts think that the recent rally is not enough to get many nervous investors to jump back in the market.
"If you have a lot of cash, it is because you've been concerned about the economy," said Mark Phelps, CEO of W.P. Stewart & Co., Ltd, an investment firm in New York. "There is still a lot of volatility, so a quick upturn is not going to convince you to get back in. An awful lot of investors are going to remain cautious."
Phelps said it will take a more gradual market move to prove to many skeptical investors that the worst may be over. With that in mind, he thinks that cash being put back to work into stocks is a scenario that will build over time.
But if more investors eventually regain their appetite for risk and begin to shift assets back from cash to stocks, that is undeniably a good sign for the markets, Phelps said. That is why he said his firm is trying to identify companies with solid long-term potential.
"This is not a wholesale call to arms to invest today. We accept that the economy is challenging," he said. "But we try to find stocks doing well in tough times. The market took down good companies and bad last year."
Phelps said that blue-chip consumer companies Pepsi (PEP, Fortune 500) and Procter & Gamble (PG, Fortune 500), credit card processor Mastercard (MA, Fortune 500), office retailer Staples (SPLS, Fortune 500) and fast food chain Chipotle Mexican Grill (CMG) are some examples of companies that his firm thinks are companies with strong cash flows and healthy balance sheets. His firm owns all five stocks in its W.P. Stewart & Co. Growth fund.
James Denney, portfolio manager with Mohawk Asset Management, an institutional investment firm in Schenectady, N.Y., agreed that it is a good time to buy high-quality companies that have growing dividends.
To that end, Denney said his firm has recently bought shares of United Technologies (UTX, Fortune 500) and Nike (NKE, Fortune 500).
However, Denney's Electric City Value fund now has more than 20% of its assets in cash. Denney said he is not convinced the broader market can maintain its heady pace -- and that means that many stocks are now starting to look too expensive. So he'd rather preserve cash for a time when there are more bargains again.
"There is still a lot of turmoil in the market. I don't think the market will be able to sustain the momentum it's had. Given that, valuations won't break out of the range they are in now," Denney said.
Still, some believe that many individual investors may miss the best part of the market's rally because they are still afraid to dip their toes back into stocks.
The fear is understandable, said Frank Ingarra, Jr., an assistant portfolio manager with Hennessy Funds. But he worries that individual investors may wait too long to start investing again.
"People got burned. Their 401(k)s became 101(k)s," Ingarra said. "But unfortunately for the average investors, they may get in too late. Hopefully, people realize that it's time in the market and not timing the market."
But others think that might not wind up being a concern. That's because many investors may have had their faith in stocks irrevocably shaken in this bear market.
For older investors who had been gearing up for retirement and are now needing to work longer because of the market's plunge, it may be impossible to convince them that putting money in stocks is a good idea.
"Some Baby Boomers that bought into the story of long-term investing, diversification and the notion that stocks go up 10% per year have taken money out of the market and are not putting it back in. They may never put it back in," said John Norris, managing director of wealth management with Oakworth Capital Bank in Birmingham, Ala.
And just because some investors are putting cash back to work is not necessarily a bullish sign.
For one, as wary as some mutual fund managers may seem right now, they aren't nearly as conservative as they were during the last bear market. According to Morningstar, 37% of U.S. stock funds had more than 5% in cash at the end of 2000 and 38% weren't fully invested at the end of 2001.
So cash that has been plowed into stocks during this furious rally could easily come flowing back out if there is more bad news. And Norris thinks that could be the case once the government releases more information about how big banks fared on their stress tests early next month.
"This recent pop may have been fueled by a little bit of cash sitting on the sidelines. But once that cash is in, what comes next?." he said. "Once we get the results of the stress tests on May 4, some bright minds may pore over the data, and see that banks are still in a world of hurt and pull out of the market."
Want a Money Makeover? E-mail us at makeover@moneymail.com. For the CNNMoney.com Comment Policy, click here. 
