March 12th, 2009 by GreenLight Advisor

The following charts are real eye-openers. By now, its no secret, it been widely reported, that there are some $8-trillion dollars sitting in cash and cash equivalents; record levels. What’s been less discussed is what this cash balance is relative to the total market cap of the S&P500 and Wilshire 5000 indices.

According to chart #2 below, cash relative to the market cap of S&P500 is over 100%, and, chart #3, over 90% relative to the Wilshire 5000. This is remarkable, as these numbers hold the key to a recovery in equity markets.

The question remains though, where will cash be deployed, when the market decides to reinvest? The record proportion of cash and cash balance relative to market capitalization does suggest that we may raise our optimism levels, but it seems clear the equity market will require reassuring signs or catalysts to nudge it back into a long bias, where sell volumes cease to outweigh that of buyers. And equities are not the only choice for investors these days. The longer equity markets take to provide investors reassuring signs the greater the likelihood that investors will opt for a larger share of their savings into the bond market, to move further along in duration for the yield.

You see, Washington must amortize trillions of dollars in short term liabilities, the war, bailouts and stimulus, over the longer term, as well as retire some of the additions to the money supply, thanks to quantitative easing. Over the next year or two, poor conditions in the stock market will, on an increasing basis could help crowd-in a larger share of the market’s cash into the the longer end of the bond market.

Take a look at global bonds or global bond funds. They have been outperforming, as a result of flight to quality, and falling long-term yields, but the aversion to invest in them has been the result of post- quantitative easing fears of hyperinflation. We may however, have much more time than we realize right now before we have to worry about hyper-inflation, while the G6 world continues to deleverage itself from its enormous debt obligations. Remember, deleveraging is not simply a retirement of debt, it entails the liquidation of assets. This is mostly the reason for the ongoing asset deflation that we have been experiencing.

Therefore, the areas of the market that are more likely to do well are those that do not require credit to thrive. Credit-hungry or credit-burdened, cash poor sectors, companies and country bets will continue to be troubled by credit tightness. Cash-rich, under-levered sectors, companies, and country bets will likely be favoured for their clean balance sheets and under-requirement of credit and soundness as part of their business model.  The flow of funds to the latter, the beauty contest winners, could be unbalanced in their favour when the time comes.

Money on the Sidelines

Charts: Todd Sullivan, ValuePlays

Source: Thomson Reuters Datastream

Hat tip: MarketFolly.com