Saturday, January 12, 2008

The Flight to Safety – Money Markets at record levels

I always keep a stash of cash in a Money Market fund. It’s usually a hefty amount – at least 3X my annual expenses. It serves multiple purposes:

1) It’s my emergency fund. Notice that I said 3X my expenses and not 3X my salary. If necessary, I could live for 3 years on this money.

2) It provides some asset diversification with a solid rate of return at almost no risk. My portfolio is heavily weighted in stocks. I have very little in bonds, so I consider this as my only fixed income asset.

3) and it's my holding area. All new money coming in to my portfolio first goes through this money market account. I invest from this account using dollar cost averaging as well as one time stock or mutual fund buys to keep my asset allocation balanced.

In volatile markets, like the last couple of months, I have continued to make the automatic DCA purchases, but have held off on any other buys. I don’t expect to find the market bottom, but I would like to wait until I think the market is sufficiently wrung out, before investing large sums. Consequently, my Money Market account is starting to balloon.

This does not go unnoticed by the financial community. In fact, they are watching and waiting for all of us to flee to the safety of MMs. Since, people tend to put their money into MMs in times of uncertainty, they reason that once MMs reach record levels and the market is wrung out, stocks will then rally.

Money Markets are now at record levels
MMs are 30% above the previous peak in 2003. Wow! This must be the sign. But, hold on. Would you believe that the amount invested in stocks is also at record levels? The equity in stocks is 43% above the previous peak set in 2000.

We have had a very successful bull run for the last several years building a lot of equity into the market. Of course, that 43% number is based on current stock prices and as the market continues to decline that number will also decrease.

Show me the Money
To get a better idea of where the money is going, we need to look at the two assets relative to each other. I have included the chart below (from Minyanville) which combines the data to come up with a ratio of total Money Market assets to total stock fund assets. The chart gives a very good indication of investor sentiment.

Money Market assets are currently 40% of equity fund assets, well below the bear market peak of 77% following the dot com bust. I consider the dot com bear market to be akin to the 40 or 50 year flood – its going to flood again and again, but it is unlikely that it will be as bad as the 2000 disaster. So, I don’t expect that we will hit the 77% number, but we do have a ways to go before this market turns around.

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