With analysts and commentators everywhere coming up with all kinds of nonsensical “fundamental” reasons why the market has rallied (strangely performance gaming and manipulation never seem to get mentioned), I thought it worth seeing if indeed there were investors who were “buying” stocks today.
Few metrics gauge this as well as mutual fund cash levels. With over $10 trillion in assets, stock-based mutual funds are a decent benchmark for the “herd.” With that in mind, it’s worth noticing that mutual fund cash levels are at their lowest levels in over 40 years!
That’s right, mutual fund cash levels are lower than they’ve been in 40+ years. Lower than they were during the Tech bubble and lower than they were when the market put in an all time top at the peak of the housing bubble. Put another way, mutual funds are more “all in” than they’ve been in 40+ years.
On top of this, the financial system is even MORE leveraged than it was during the Tech Bubble.
Source: Diapason Commodities Management
The above chart shows the level of leverage in the financial system: essentially how much borrowed money exists relative to actual capital. The first large peak is the Tech Bubble. The second large peak is the Housing Bubble. The third peak is today.
In simple English, this chart shows us that the financial system currently has even MORE leverage than during the Tech bubble. Put another way, asset prices today are being held up by borrowed money. This is also known as a Bubble.
The last two times we were at these levels or higher, the financial system suffered a severe Crash (the Tech Bust and 2008). I full believe we are fast approaching another Crisis… however, this one will be different for one key reason: people will finally give up hope in the Fed’s ability to manage the financial system.
Taken in the context of the mutual fund cash levels chart I showed before, this indicates that not only is the financial system more leveraged than during the Tech bubble, but mutual funds are more heavily invested than at any time in the last 40+ years.
To say that the potential for a full-scale market collapse is high would be a gross understatement. Should the market begin to crater, the margin calls (when an investor has to put up more capital to cover a losing position that was bought using borrowed money) could be absolutely enormous.
This is what happened in 2008 when the market entered a free-fall: large institutional investors who were overcommitted to the market had to sell positions to meet redemptions (when investors pull their money).
This, in turn, forced other large investors (especially those who had borrowed money) to sell positions to cover their losses and return the funds they borrowed. And thus we entered a negative feedback loop in that the lower the market fell, the more investors had to sell.
This is how Crises take place. Ad the next Crisis is not far away. Indeed, Europe is already beginning to experience it. Interbank lending rates there are now on par with the levels that occurred in the wake of Lehman Brothers’ collapse. Put another way, European banks no longer trust each other enough to lend to other banks.
This is precisely what hit in the US in 2008. And it will come to these shores again in the near future. The leverage levels and the mutual fund cash levels are already warning us of this.
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