Keep a Close Eye on Institutional Cash


I find the assets of institutional money-market fund, published by the Fed on a weekly basis, an extremely useful tool in determining the direction of the U.S. stock market. Institutional money-market funds comprise approximately 65% of all money-market funds but to focus on liquidity in terms of value per se may be misleading, though, as the asset allocation including liquidity of retirement funds is highly regulated. The actual liquidity of regulated funds in terms of value is therefore likely to grow in line with the overall value of retirement funds in rising stock markets.

Although not scientifically correct, I express the institutional money-market funds as a percentage of the total U.S. stock market capitalization as represented by the Wilshire 5000 Price Index as a proxy of total institutional funds to get a better picture of institutional fund liquidity, and named it the institutional liquidity ratio. In the graph below it is evident that the liquidity ratio remained virtually unchanged from 1991 to end 2000, meaning that liquidity moved in line with the broad stock market. Since the end of 2000 the face of fund management changed as five major events rocked investors: 1) the ICT bubble finally burst; 2) 9/11; 3) U.S. corporate scandals; 4) the housing bubble; 5) Lehman/great financial crisis. The events in 1, 2 and 3 took the liquidity ratio to 15% while the Lehman Saga and the subsequent global financial crisis saw the liquidity ratio peak at 35%.

liquidity ratio vs sp500

Sources: FRED; I-Net Bridge; Plexus Holdings.

The value of the liquidity ratio lies in its smoothed annualized growth rate that is calculated by using linear smoothing − similar to how I estimate ECRI in calculating the smoothed annualized growth rate of the WLI.  When the growth rate surged in the third quarter of 2000 it indicated a change of heart by fund managers as they upped their liquidity at the cost of stocks, resulting in the ensuing bear market in stocks. When they slashed their liquidity levels in favor or stocks in the second quarter of 2003 it happened to be the bottom of the market. In 2006 the first warning signals appeared as the growth rate of the liquidity ratio turned positive. In the fourth quarter of 2007 the growth rate of the liquidity ratio jumped as institutions again favored liquidity ahead of stocks. When the growth rate of the liquidity ratio turned negative again, indicating that institutions were again favoring stocks, the downtrend in the S&P 500 since the start of 2008 was finally broken. It is also clear that the institutions have favored equities ahead of cash since then, except for a slightly positive move in the liquidity ratio’s smoothed growth in October last year.

liquidity ratio nsa smoothed annualized growth rate

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