Tuesday, May 26, 2009

Mutual Funds waiting with cash on the sidelines? What cash?

Last Saturday, May 23 '09, there was an article in the mutual funds news section of the Economic Times that made me sit up and start thinking.

For the 6 months period from Oct 1 '08 to Mar 31 '09, 14 mutual fund houses borrowed almost Rs 21000 Crores to meet investors' redemption requirements. That's over $ 4 Billion.

Biggies like Reliance (Rs 6000 Cr), Religare (Rs 4400 Cr), Birla Sun Life (Rs 3400 Cr) and Tata (Rs 3000 Cr) led the pack. Most of the loans, taken at high interests, have apparently been paid back. But that is small comfort.

Even today, a very articulate and confident lady analyst on CNBC paraphrased an oft-repeated refrain: 'There is plenty of cash waiting on the sidelines'!

If that is correct, then what was the need to borrow huge amounts at high interest rates? What happened to the cash on the sidelines? Or is it one of those enduring myths in the stock market that need to be debunked?

In an article last week, I had debunked another stock market myth. That had sparked off quite a debate in one of the investment forums. So this week I've decided to bring out the heavy artillery.

In Mar 2007, John P. Hussman, PhD (http://www.hussmanfunds.com/wmc/wmc070312.htm) had this to say about the 'Money flow Myth':-

"I am increasingly losing confidence that Wall Street operates on a well-defined base of knowledge. Instead, I am struck by the number of platitudes and false constructs that seem to dominate the investment management industry.

First, we should be very clear that there is no such thing as money going into or out of a secondary market. When stocks are issued in an IPO, or bonds are floated to investors, companies receive funds from investors and, in return, give investors pieces of paper called stocks and bonds, as evidence of the investors' claim on some future stream of cash. This is a “primary market” transaction.

Once those pieces of paper are issued, they are traded between investors in the “secondary market.” When we talk about the stock market, we're talking almost exclusively about the secondary market, because new issues make up a very small part of total activity.

Dear Wall Street analysts and financial reporters – when investors purchase a stock in the secondary market, the dollars that buyers bring “into” the market are immediately taken “out of” the market in the hands of the sellers. It is an exchange. This is why the place it happens is called a “stock exchange.” The stock market is not an air balloon into which money goes in or out and expands or contracts that balloon. Nor is it a water balloon that is expanded by pouring in “liquidity.” Prices are not driven by the amount of money that buyers “put in” or sellers “take out” (as those dollar amounts are identical). Prices are determined by the relative eagerness of the buyer versus the seller.

If a dentist in Poughkeepsie is willing to pay up 10 cents to buy a single share of General Electric, the total market value of General Electric increases by over $1 billion (GE has 10.28 billion shares outstanding - do the math). In this way, market capitalization can be created and destroyed out of thin air and on the smallest of trading volumes. So you'd better be sure that the there is a sound and fairly reliable stream of expected cash flows backing up the value of the securities you're buying.

Cash does not ever find a “home” in a secondary market. Every time you hear the phrase “investors are putting money into…” or “investors are taking money out of …” or “money is flowing out of … and into …,” it is a signal that the speaker is unable to distinguish a secondary market from a primary one.

As I used to teach my students, if Mickey sells his money market fund to buy stocks from Ricky, the money market fund has to sell some of its T-bills or commercial paper to Nicky, whose cash goes to Mickey, who uses the cash to buy stocks from Ricky. In the end, the cash that was held by Nicky is now held by Ricky, the money market securities that were held by Mickey are now held by Nicky, and the stock that was held by Ricky is now held by Mickey. There may have been some change in the relative prices between cash, money market securities and stocks, depending on which of the three was most eager, but there is precisely the same amount of “cash on the sidelines” after that set of transactions as there was before it."

Hussman had written an earlier article on the subject as well: 'There's No Such Thing as Idle Cash on the Sidelines.'   

Guess an old myth becomes as comfortable to use as an old pair of shoes. And mutual fund managers and stock market analysts would rather feel comfortable than do some independent thinking.

1 comment:

Titu said...

Hello Sir,

whatever I read in your blog post is PURE COMMON SENSE, and that's the reason why I like to read your blog post