There’s Plenty of Dry Powder to Invest in Stocks

• Mutual funds have 18.4% of their assets in cash, according to State Street.
• In 2014, those same investors’ cash allocation troughed at 10%.
• That implies they have about $3 trillion worth of cash holdings to invest.

The stock market is likely overdue for a pullback… but if we experience one before the end of the year, don’t expect it to last for long.

The S&P 500 Index has been on a tear this year. Through yesterday’s close, the gauge is up almost 25.5%, with 3.5% of the increase coming after last week’s presidential election. If these gains hold, 2024 will surpass the 23.2% surge in 2023, and mark the best two-year return since the dot-com boom in the late 1990’s…

But given the gains, investors everywhere are increasingly nervous. After all, the S&P 500 is trading at a 22.2 times multiple of its forward 12-month earnings. That’s above the five- and 10-year averages of 19.6 times and 18.1 times, respectively. And, considering the index averages a roughly 9.5% total return (dividends reinvested) since 1928, these last two years have upped those anxieties.

Yet, those concerns may be overblown. You see, despite the run-up, both Wall Street and Main Street are sitting on a huge pile of cash. Due to high interest rates, money markets offer an attractive return. According to personal-finance website NerdWallet, the best money market accounts offer a rate of just over 5% a year.

As a result, total money market assets have surged to a record $6.6 trillion. However, while those assets are safe, they’re not making the kind of returns they could be in the stock market. And based on recent data from State Street, there’s plenty of room for institutional investors to draw down that money to invest in stocks before we have to worry about it troughing. That tells me that any pullback in the S&P 500 will be short-lived.

But don’t take my word for it, let’s look at what the data’s telling us…

If we want to see where investors are parking their money, there’s an easy way to track it. We can follow the weekly fund flows from the Investment Company Institute (ICI). It’s an industry association that represents U.S. asset managers. Its member companies manage more than $30 trillion domestically and almost $9 trillion overseas. Every Thursday it releases the details of fund flows by its member companies.

Like I stated above, there’s almost $6.6 trillion parked in money market funds currently…

But that number is the total picture. ICI takes it a step further by breaking it down into both institutional and retail assets. According to the totals, institutional money managers have a record $3.9 trillion stashed in the safety of money markets…

And retail assets sit at $2.7 trillion…

But it’s the institutional part that we want to pay attention to. Because, according to financial-services provider State Street, mutual fund managers still have plenty of appetite for risk assets… and those funds’ cash holdings would need to be cut in half before they reached the trough last hit in 2014.

State Street’s risk appetite indicator is designed to follow institutional investor flows. It “tracks data across stocks, bonds, currencies, and commodities, as well as across asset classes by examining equity and cash weights.” The gauge also gathers information on buying and selling activity by real-money funds and excludes data from leveraged funds. In other words, the results more closely follow the activity of mutual funds rather than hedge funds.

When the score is above zero, fund managers are interested in buying risk assets (like stocks), and when the gauge falls below zero, they’re trying to avoid those same investments. According to the most recent result, mutual fund managers’ risk appetite score sits at 18.2...

According to State Street, one of the drivers of the positive risk appetite was last week’s presidential election. Money managers expected a victory by former President Donald Trump, predicting it would support the domestic economy. So, they started increasing their allocation to stocks.

But that wasn’t all… State Street also said money managers have been selling foreign assets in anticipation of potential tariffs, while increasing their dollar holdings. We can see that by looking at this chart of cash allocations…

The chart above shows the percentage of mutual holdings allocated to cash over the last 20 years. According to the most recent reading, the number sits at 18.4%. But if we look back to the trough in 2014, cash holdings dropped to roughly 10% of total assets.

But let’s put the numbers in perspective. According to recent industry data, U.S. mutual funds have roughly $34.4 trillion in assets. If we multiply that number by 18.4%, they currently have about $6.3 trillion in cash (including money market assets).

Now let’s see what the low end of the range looks like by applying the 2014 numbers. Based on the prior example, the trough cash level would be around $3.4 trillion. In other words, those fund managers have about $3 trillion in excess cash they could invest.

So, like I said at the start, the stock market has experienced a tremendous run so far this year. When we consider that in light of last year’s gains and the current forward 12-month earnings multiple, you can see the reason for hesitation at current levels.

But if the incoming administration is able to enact some of the pro-growth policies it’s looking to pursue, that could improve the outlook for corporate margins. If that happens, it will drive earnings higher and drop the price-to-earnings multiple for major market indexes lower. The shift will encourage investors to put more cash to work, underpinning a steady rally in the S&P 500.

Five Stories Moving the Market:

Australia’s Wage Price Index advanced at an annualized pace of 3.5% in the three months through September, compared with 4.1% in the prior period and economists’ estimate of 3.6%, according to Australian Bureau of Statistics data – Bloomberg. (Why you should care - the data support policy easing by the Reserve Bank of Australia)

Republican senators’ secret ballot vote Wednesday for a new leader will test how much lawmakers want to shake things up as they enter an era defined by the populist energy that propelled President-elect Donald Trump back to the White House – WSJ. (Why you should care – the Senate is expected to keep a lid on much of Trump’s spending plans)

Minneapolis Federal Reserve Bank President Neel Kashkari said he feels U.S. monetary policy is currently "modestly restrictive," with short-term borrowing costs continuing to slow inflation and the economy, but not by a lot – Reuters. (Why you should care – Kashkari said economic growth will be the guide for how much the central bank cuts rates)

Richmond Fed President Thomas Barkin called the current level of interest rates "somewhat less restrictive" than it had been, saying the Fed is in position to respond appropriately regardless of how the economy evolves – Bloomberg. (Why you should care – Barkin, who tends to be hawkish, is signaling a willingness to cut rates more)

The Federal Reserve should play a minimal, supportive role in payments infrastructure, letting the private sector take the lead, according to Fed governor Christopher Waller – WSJ. (Why you should care – the comments point to a less restrictive financial-market approach, potentially boosting the liquidity outlook)

Economic Calendar:

China – New Yuan Loans for October

Japan – PPI for October

BOE’s Mann (Board Member) Speaks (4:45 a.m.)

MBA Mortgage Applications (7 a.m.)

CPI for October (8:30 a.m.)

Fed’s Logan (Dallas) Speaks (9:35 a.m.)

Energy Information Administration Crude Oil Inventory Data (10:30 a.m.)

Fed’s Schmid (Kansas City) Speaks (1:30 p.m.)

Federal Budget Balance for October (2 p.m.)