Debunking the "Money on the Sidelines" Myth

Everyone says that massive amounts of money are sitting on the sidelines, and will rush in and rally the markets any second now.

Are they right?

Well, as Henry Blodget pointed out in June, the entire concept of "money on the sidelines" fails to reflect the reality of how markets actually work:

The stock market is obviously poised for a gigantic advance because there's a "ton of money on the sidelines." Right? All that money will soon come off "the sidelines" and "into" the market, and it will inflate the market like a gigantic hot air balloon, driving prices to the stars.

Right?

After all, that's why stock prices are low now, right? All that money has "left the market" and is "hiding on the sidelines."

Actually, no. That's just what everyone on CNBC says. [Economist and] fund manager John Hussman explains what really makes stocks go up and down:

...When investors purchase a stock in the secondary market, the dollars that buyers bring “into” the market are immediately taken “out of” the market in the hands of the sellers. It is an exchange. This is why the place it happens is called a “stock exchange.”

The stock market is not an air balloon into which money goes in or out and expands or contracts that balloon. Nor is it a water balloon that is expanded by pouring in “liquidity.” Prices are not driven by the amount of money that buyers “put in” or sellers “take out” (as those dollar amounts are identical). Prices are determined by the relative eagerness of the buyer versus the seller...

As I used to teach my students, if Mickey sells his money market fund to buy stocks from Ricky, the money market fund has to sell some of its T-bills or commercial paper to Nicky, whose cash goes to Mickey, who uses the cash to buy stocks from Ricky. In the end, the cash that was held by Nicky is now held by Ricky, the money market securities that were held by Mickey are now held by Nicky, and the stock that was held by Ricky is now held by Mickey. There may have been some change in the relative prices between cash, money market securities and stocks, depending on which of the three was most eager, but there is precisely the same amount of “cash on the sidelines” after that set of transactions as there was before it.

So what really happens when all that money gets up out of cash accounts

and comes "into" the market? It goes into someone else's cash account. And maybe they put it back "into the market" (into someone else's cash account). And so on.

So beware morons talking about "all that cash on the sidelines." Really what they're talking about is bearish investors who may one day become bulls and be more eager to buy stocks than their current owners are to keep them (which will drive the prices up).

Similarly, Mish noted in November:

The amount of "sideline cash" has been rising for years and will keep doing so unless money supply contracts. Yet the S&P 500 fell close to 40% anyway. Why? The reason is simple: Earnings were horrid the price people were willing to pay for those earnings dropped.

Stock prices rise and fall on sentiment changes every single day, not because money flows into or out of the market.

Mish, Zero Hedge and others also point out that the U.S. consumer has been run over by a truck, that there has been a long-term change in consumer sentiment, and that it is unlikely the average consumer is going to go all-in with stocks. For example, Zero Hedge points out that American household equity declined by 94% between the end of 2007 through Q1 of 2009.

After being burned by the crash and the destruction in value of assets they were told were "safe", many Americans will keep their money under their mattress (or the modern equivalents, such as money market funds) for many years to come.

At the very least, we should remember that history shows that "cash on the sidelines" is not a very persuasive argument.

As Zero Hedge asks:

Was the statement below just uttered by [current network news financial talking heads], or did it appear first more than 79 years ago?

There's a large amount of money on sidelines waiting for investment opportunities; this should be felt in market when “cheerful sentiment is more firmly intrenched.” Economists point out that banks and insurance companies “never before had so much money lying idle.”

If you answered "the latter" you were correct. It first appeared on August 28, 1930 to be precise (and who knows how many times prior, usually showing up just as America was set for yet another major recession).

The same question...:

Fed. Reserve seen continuing easy credit policy pursued since start of year. Some concern that increased reserve credit “will flow into speculative channels,” but this doesn't seem to have happened much yet.

Correct - 1930.