The Buy Side Brief: Are high levels of sidelined cash supportive for equities?

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Lower rates will move money from sidelines

Simon Bonouvrie, Portfolio Manager, Cadence Asset Management 

High levels of cash are supportive for the market to a certain extent.  As long as market volatility remains low, company valuations remain attractive and there is the prospect for earnings & dividend growth then money will flow into the equities market.  The main catalyst for money moving from the sideline into the market is lower interest rates.  When rates go lower investors with cash are forced to find higher returning (and higher risk) assets classes such as equities.  For example bank sector stocks are yielding approximately 5.5% fully franked with the prospect for small growth in the dividend.   This compares favourably with bank term deposit rates on offer of just over 2% unfranked. 

‘Wall of money’ theory historically fickle

Don Williams, Chief Investment Officer, Platypus Asset Management

We don’t believe that high levels of cash necessarily support the equity market per se.  The relationship between the cash rate, the amount of cash people have in the bank and equity valuation is more subtle, and variable. The ‘wall of money’ theory supporting markets has been a fickle one from a historic point of view and we would argue that corporate earnings and market sentiment are far more important. Despite high cash levels and low interest rates, Australian equities have lagged most developed markets, mainly due to the lacklustre earnings growth of Australian listed companies.  To put this in context: aggregate earnings remain circa 20% below the pre-GFC level.  Only when we see reasonable and sustainable earnings growthwill the market perform better in absolute and relative terms to other equity markets.

Periodic liquidity vacuums create opportunity in small and micro-caps

Chris Prunty, Analyst, Ausbil Microcap Fund

From a small to micro-cap perspective I’m not sure cash moving from the sidelines is a hugely relevant driver of returns.  My guess would be that cash-holding investors don’t wake up one morning and put their cash to work in smalls.  Typically what happens is large caps lead, generate some good performance and then as risk appetite and confidence in markets improve that confidence trickles down to mids, smalls and micros.  Notwithstanding this, the ebbs and flows of liquidity are hugely important to price action in small and micro-cap stocks and having the mindset (and the cash reserves) to take advantage of the periodic liquidity vacuums is important.  Preparation, patience, discipline and opportunism are useful characteristics for the small cap investor.