The stock market is obviously poised for a gigantic advance because there’s a “ton of money on the sidelines.” Right? All that money will soon come off “the sidelines” and “into” the market, and it will inflate the market like a gigantic hot air balloon, driving prices to the stars.
After all, that’s why stock prices are low now, right? All that money has “left the market” and is “hiding on the sidelines.”
Actually, no. That’s just what everyone on CNBC says. Fund manager John Hussman explains what really makes stocks go up and down:
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 maths). In this way, market capitalisation 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.
So what really happens when all that money gets up out of cash accounts and comes “into” the market? It goes into someone else’s cash account. And maybe they put it back “into the market” (into someone else’s cash account). And so on.
So beware morons talking about “all that cash on the sidelines.” Really what they’re talking about is bearish investors who may one day become bulls and be more eager to buy stocks than their current owners are to keep them (which will drive the prices up).
Now you know!