With the Treasury portion of QE ending in 3 days (October 29 is the last scheduled POMO for this iteration of QE), and the MBS problem refusing to go away even as the Fed only has $400 billion in dry powder left to keep mortgage rates palatable, the question becomes where will new forms of liquidity come from in order to satisfy the parabolic run up in the market. As traditional conduits of risk transfer are still shunning stocks, with equity mutual funds yet to report a positive fund flow number for 2009, the question of whether there really is any substantial money on the sidelines to take over for the Fed's liquidity dump takes center stage. Goldman Sachs presents one analysis according to which there is $600 billion of potential equity allocatable capital from individuals, institutional investors and companies. Yet with unemployment hitting 10% shortly, and still massive corporate debt loads needing to addressed, one wonders if Goldman is premature in its optimistic outlook.
Here is how Goldman outlines the various forms of potential new money flow into stocks:
- Individuals: $350 billion of potential money flow into equities
We expect $600 billion of outflows from the $1.9 trillion of taxable money market mutual funds owned by individuals, with 50% going to stocks split between equity mutual funds and direct share purchases. Robust outflows YTD have benefited bond funds but have not yet benefited equity funds. An additional $50 billion could flow from savings to the US equity market.
- Institutions: $150 billion from hedge funds and foreign investors
US mutual funds no longer hold large cash positions as a percentage of total assets. If hedge funds modestly re-lever it would total $50 billion of equity inflow. Foreign investors buy $100 billion of US stocks annually.
- Corporations: $100 billion net flow from buybacks, M&A, issuance
Non-financial corporations hold $760 billion in cash, reflecting the severe cutback in all forms of capital spending. We expect $250 billion of cash M&A, buybacks, and pension spending offset by $150 billion in issuance.
The primary observations here are that more than half of the projected stock purchasing power is expected to come out of retail sources, with the logic being that money market fund returns are sufficiently unattractive to force even more money out of MMs and into stocks. Goldman expects a $1 trillion decline in taxable money market assets over the next year (from $3 to $2 trillion).
A summary of net flows by sources into various asset classes over the past 3 years paints a mixed picture.
Yet while it is very debatable just how willing a stressed, tapped out and still very leveraged consumer would be to throw their money into a market that now trades at a forward P/E multiple that nobody in their right mind would call a bargain, Goldman does share the following insight about mutual funds, which it would appear no longer have the massive purchasing power they did in the beginning of the year.
Equity mutual funds no longer hold large cash positions as a percentage of assets.
The ratio of cash to total assets rose to a high of 5.5%; it has now corrected to 3.9%, near the record low of the past decade. The S&P 500 is up 20% YTD and up 60% from the March low, but US equity mutual funds have had $9 billion of net outflows YTD. US equity mutual funds need inflows in order to have net demand for US stocks.
Hedge funds continue to operate conservatively with low leverage ratios compared with history. We estimate $50 billion in net equity purchases could occur if industry leverage rises closer to the long-term average. From a gross money flow perspective, the impact of increasing leverage would be to generate perhaps $110 billion of new long and short positions. We do not expect a return to the super-leverage levels of prior years.
Thus the Goldman argument would go that retail would bypass mutual funds entirely, which has been the case so far in 2009, and approach the market directly. We believe this argument requires a significant leap of faith into the naivete of the retail investing class after the biggest portfolio wipeout in many generations.
For these and many more detailed observations on how Goldman is presenting the case for over half a trillion in equity purchases still to come, we refer readers to the report below.