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As a group, mutual fund managers are as good a contrarian indicator for the stock market as they come. History shows that they hold relatively high cash levels at the beginning of a bull market. Then at the end of a bull market they don’t have much cash since they’re more or less fully invested.
And if you look at mutual fund cash levels in relation to the S&P 500 over the years, as shown in the chart below, you can easily spot this pattern.
High Cash Levels in the 1980s,
Low Cash Levels in 2000
Based on my research, high cash levels of more than 8 percent dominated the early 1980s until the early 1990s. During most of that time stocks were attractively valued, and they staged a huge rally from 1982 to 1987, and again thereafter.
In 1995, when the stock market bubble began, mutual funds’ cash levels started to decline in earnest, falling below 7 percent. By 2000, at the height of the bubble, they had come down to 4 percent. This was close to the low point of 3.9 percent reached in 1972 … at the top of a bull market after which stocks lost nearly 50 percent.
Today we know that March 2000 was the climax of the 1995 bubble. And after going sideways for the rest of 2000, a huge bear market began, and the S&P 500 lost more than 40 percent.
Low Cash Levels in 2007,
And Low Cash Levels Now
Despite those huge losses, cash levels did not rise by much. And after hitting 6.5 percent at the end of 2000, fund managers quickly started to put most of the entrusted money back into the market.
By 2005 cash levels had fallen below the 4 percent boundary. And in the summer of 2007 they hit a record low of 3.5 percent. The market topped shortly thereafter and then lost more than 50 percent!
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| It takes cash to fund a rally. And right now, mutual funds don’t have much. |
Now we’re seeing a similar pattern evolve: Near the stock market’s low in 2009, cash levels reached nearly 6 percent. Then they rolled over sharply and quickly fell back below the 4 percent threshold. They are currently at 3.8 percent.
Low Cash Levels Signal
High Market Risk
Mutual fund cash levels are not a short-term, stock market timing tool. However, they do give us another gauge to compare current market conditions to what has happened in the past.
So are cash levels on their way down to 3.5 percent? Will they reach new historical lows in the coming months? Or is 3.8 percent low enough to signal the end of the current bull move?
No one really knows for sure. But what I do know is that it takes cash to fund a rally. And right now, historically speaking, mutual funds don’t have much of it. To me, that’s a sign of a very risky stock market environment.
In the bigger picture I see the stock market in a secular bear market that began in 2000. And much higher mutual fund cash levels are needed before the next secular bull market can begin.
Best wishes,
Claus
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