Wall Street is once again touting the idea that there is a colossal wave of cash waiting to flood into the stock market, propelling stock prices to new heights.
The recent sales pitch from a prominent Wall Street figure at a conference in Hong Kong highlights this notion. Mark Wiedman, the head of global client business at BlackRock, stated, “There’s about $4 trillion of cash, sloshing around, waiting for action.”
Similarly, Andrew Schlossberg, the president and CEO at Invesco, expressed his concern about the excess cash sitting on the sidelines and pondered ways to bring it back into the marketplace.
However, believing in this theory requires a considerable leap of faith.
The concept of “money on the sidelines” is a common fallback used by market participants to instill hope when share prices stagnate or decline, as they have been recently.
At first glance, the idea seems plausible. Many individuals have money deposited in banks that could potentially be used to buy stocks. But here’s the catch—every time someone buys a stock, someone else must sell it. So, while an individual can invest their $10,000 in stocks, the collective cannot do so. This is the fallacy of composition.
To illustrate: if an individual with $10,000 decides to invest it in stocks, they can only do so by finding existing shareholders willing to sell their shares for $10,000. The money changes hands, but that’s about it.
The latest Federal Reserve Financial Accounts of the United States reveal staggering sums of money held by households and nonprofits—$4.4 trillion in checking accounts and cash, $9.8 trillion in certificates of deposit and savings accounts, and $3.5 trillion in money-market accounts. However, this vast amount of money cannot simply pour into the market as envisioned.
So, while Wall Street may continue to sell the enticing idea of untapped cash reserves waiting to be deployed, it’s essential to question the validity of this narrative. The fallacy of composition reminds us that the mere existence of money on the sidelines does not guarantee its seamless entry into the market.
Ultimately, investors should approach such claims with caution and critical thinking, seeking a deeper understanding of the complex dynamics at play in the stock market.
Thinking Beyond Stock Buybacks
Many people assume that stock buybacks have a significant impact on the overall financial system. However, this may not be entirely true. Even when companies use their own cash to buy back and cancel stocks, it merely reduces their share float but does not affect the amount of cash available in the financial system. The cash continues to circulate, without vanishing into thin air.
While the role of stock buybacks is often exaggerated, recent research by the Bank for International Settlements and McKinsey & Co. offers valuable insights. The Bank for International Settlements reveals that for every $2 worth of stocks bought back and canceled, approximately $1 worth of new shares gets issued. In addition, McKinsey & Co. analysts demonstrate that buybacks alone are incapable of creating value.
In contrast, there exist more compelling arguments for Wall Street enthusiasts seeking to advocate for a bullish market sentiment. For starters, we are now entering the six-month season when stocks traditionally tend to perform exceptionally well, leading to substantial monetary gains.
Furthermore, data suggests that individual investors, on the whole, are increasingly divesting from the stock market by withdrawing funds from mutual funds and exchange-traded funds. History indicates that by adopting the opposite approach to these investors, one can usually generate profits.
However, there is a need to address some significant questions raised by skeptics regarding the valuation of U.S. stocks. According to Yale professor Robert Shiller’s numbers, stock prices are currently more expensive compared to levels observed in 2007 or even 1929. Additionally, why should stock prices remain elevated despite the significant increase in bond yields over the past two years?
Moreover, critics of the infamous “cash on the sidelines” argument point out that households had more funds allocated to bank accounts, cash reserves, and money-market funds at the end of 2021 than at present. Surprisingly, this abundance of available cash did not prevent the decline of stock and bond markets.
In conclusion, it seems prudent to move beyond the hype surrounding stock buybacks and consider a broader array of factors when evaluating investment opportunities.
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