Will Sidelined Investors’ Patience End Soon?
COVID. A Gyrating stock market. Economic uncertainty. A Presidential Election. These and other factors have combined to push funds held in money markets by retail and institutional investors to all-time highs. According to the Federal Reserve Bank of St Louis Economic Research, at the end of September, retail investors held $1.09 trillion in money market funds, down slightly from the all-time high of $1.15 trillion at the end of May this year and well above the $600 billion-$800 billion range typically held over the past decade. Institutional investors held $3.0 trillion in money market funds at the end of September, down slightly from the $3.2 trillion peak earlier this year and well above the historic $1.6 trillion-$2.0 trillion range over the past decade.
Combined, there are some $1.5-$2.0 trillion of above-average funds being held in money markets today. Put another way, a potential $1.5-$2.0 trillion of Dry Powder. The Dry Powder amounts to 4.2%-5.6% of the entire market capitalization of all publicly-traded companies in the U.S. A not insignificant sum if it were to be re-invested in the stock market.
While moving to the sidelines in uncertain times is the historical norm, how long can this behavior last? The FDIC reports the average money market rate at 0.08% APY. Bank Rate reports the best (our emphasis) 1-year CD rate at 0.75%, 2-year at 1.00%, and 5-year at 1.35%. But the U.S. Labor Department reported the annual inflation rate for the 12 months ended September 2020 was 1.4%. And the Federal Reserve Bank of Philadelphia reports the estimated long-term annual inflation rate at 2.05%. Obviously, on a real basis, holding funds in such investments reduces one’s inflation-adjusted net worth. And this is exacerbated for institutional investors who typically are being paid to invest money, not have it sit on the sidelines.
What about other investment alternatives? MacroTrends reports the current 10-year treasury yield at 0.67%, the lowest rate over the last 60 years. At some point, one would expect treasury yields to begin to rise, which would result in prices of such bonds to decline. Gold at $1,899 per oz is not too far off its 100-year inflation-adjusted high of $2,268 hit in 1980. And while debate rages about the usefulness of gold as a hedge, gold does not pay a dividend and can oftentimes incur carrying costs. And even property values are hitting all-time highs. The St. Louis Fed reports the S&P/Case Shiller U.S. National Home Price Index is at an all-time high of 221, up substantially from the previous high of 184 hit in the summer of 2006.
One potential use of the Dry Powder could be to trim household debt. Household debt hit a record high of $14.3 trillion earlier this year, some $1.6 trillion higher than the previous record during the Great Recession. Housing debt makes up the bulk of overall household debt. Revolving, credit card type of debt has dropped dramatically during the COVID crisis, while auto loans and student loan debt continue to rise. But, if the additional debt incurred was in response to lower rates, at a current 2.89% 30-year mortgage rates are at their lowest levels since at least 1971, according to Freddie Mac, consumers may not be inclined to use Dry Powder to repay such loans.
Given the alternatives, the 7% average annual return of the stock market over time may look appealing to investors seeking places to invest their Dry Powder.
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