March 8 (Bloomberg) -- Equity mutual funds are burning through cash at the fastest rate in 18 years, leaving them with the smallest reserves since 2007 in a sign that gains for the Standard & Poor’s 500 Index may slow.
Cash dropped to 3.6 percent of assets from 5.7 percent in January 2009, leaving managers with $172 billion in the quickest decrease since 1991, Investment Company Institute data show. The last time stock managers held such a small proportion was September 2007, a month before the S&P 500 began a 57 percent drop, according to data compiled by Bloomberg.
For Parnassus Investments and Janney Montgomery Scott LLC, depleted reserves is a sign returns will fall from last year, when the S&P 500 rose 23 percent, the most since 2003. Bulls say any pullback is a buying opportunity because investors have $3.17 trillion in money-market funds and may return to stocks after putting 16 times more money into bonds since last March.
“It’s not a red light, but it’s a flashing yellow light that the strongest part of the rally is probably over,” said Jerome Dodson, who oversees $3.6 billion as president of Parnassus in San Francisco and estimates the S&P 500 will climb 6 percent to 9 percent this year. “There’s not as much buying power out there.”
Investors are trying to gauge how much money is left to move shares after the S&P 500 surged 70 percent in the 10 months starting in March 2009, and then began an 8.1 percent slide on Jan. 19. The drop, which matches the average size of 117 “moderate corrections” tracked by Birinyi Associates Inc. since 1945, may herald a second phase of the bull market after last year’s advance surpassed every rally since the 1930s.
Bouncing Back
The S&P 500 has recovered almost 90 percent of the retreat that started in January, the biggest plunge in almost a year. The index recouped its year-to-date loss last week, rising 3.1 percent to 1,138.70 between Feb. 26 and March 5, following smaller-than-projected job losses and U.S. consumer spending that topped economists’ estimates.
U.S. stocks fluctuated today as American International Group Inc. increased following its $15.5 billion sale of a unit, while drugmakers sank as President Barack Obama embarked on a final push to overhaul the health-care system. The S&P 500 lost 0.1 percent to 1,137.94 at 11:47 a.m. in New York.
Cash in mutual funds slipped to 3.6 percent of assets in January, the second-lowest level on record, compared with 5.7 percent a year earlier, ICI data show. As reserves fell, the S&P 500 rallied 30 percent.
Weaker Economy
While declines in equity prices this year won’t be as severe as during the credit crisis, stocks may slump should data show the economy is weaker than analysts forecast, says Mark Luschini, chief investment strategist at Janney Montgomery. Economists project U.S. gross domestic product will increase 3 percent in 2010, up from a forecast of 1.8 percent a year ago, according to the median of 68 estimates compiled by Bloomberg.
The percentage of cash held by funds “suggests that you want to be wary of who’s left to do the buying,” said Luschini, who oversees $1.5 billion in Philadelphia. “With this recovery still relatively fragile, it would not take much to set the market up for a sizable snapback.”
The S&P 500 will rally 8.4 percent from last week’s close to 1,234 through the end of 2010, according to the average in a Bloomberg survey of 13 strategists. They recommend investors keep 7.8 percent in cash, down from 9.1 percent at the same time last year.
Cash as Harbinger
Changes in reserves foreshadowed moves in equities in the past, according to data compiled by Bloomberg and ICI. The S&P 500 lost 16 percent on average the last three times managers boosted reserves. The index doubled on average when they cut.
The index rose threefold as cash dropped in April 1993 from 9.5 percent to 4 percent in March 2000. It sank 12 percent in the next eight months as the levels jumped to 6.5 percent. The S&P 500 gained 14 percent while balances shrank from 6.5 percent in November 2000 to 3.5 percent in June 2007.
Losses of 5 percent during bull markets have usually given way to gains, according to Westport, Connecticut-based Birinyi. The 117 retreats comparable to the one that began Jan. 19 have averaged 8.5 percent over 45 days before a rebound began, the data show. The index plunged more than 10 percent 26 percent of the time.
Redeploying Assets
Stocks will rally this year as the prospect of higher interest rates lures cash from fixed-income securities to equity accounts, says Mark Bronzo at Security Global Investors. Data from ICI, the Washington-based lobbying group for professional money managers, show investors have pumped $369 billion into bond funds since March 2009 versus $23.4 billion for equities.
There’s a 57 percent chance that the Federal Reserve will raise its target rate for overnight loans between banks at its November meeting, according to data on futures trading compiled by Bloomberg. Fed Bank of Atlanta President Dennis Lockhart said in New York on March 3 that he’s “uncomfortable” with a long period of unusually low borrowing costs while still endorsing the policy of record-low rates.
“There’s so much money in the fixed-income market and there’s so much money in money-market instruments paying almost nothing,” said Bronzo, whose firm oversees $21 billion, in an interview from Irvington, New York. “If that money shifts to stock funds, it’s going to be very bullish.”
Equities may be boosted by investors deploying some of the $3.17 trillion held in money-market funds tracked by ICI. While $754.3 billion has moved from the accounts in 14 months for the fastest decline on record, Bronzo says more cash will be withdrawn as investors gain confidence in the economy.
0.04% Return
The 100 largest money-market accounts returned an annualized 0.04 percent last week, according to data compiled by Westborough, Massachusetts-based Crane Data LLC.
Valuations relative to earnings may make gains harder. While the S&P 500 is cheaper than at the end of 2009, it still trades at 18.2 times profit from the past year, the highest level since 2005.
Stocks would get cheaper should earnings rise 26 percent this year, the average estimate from analysts tracked by Bloomberg. The S&P 500 has a multiple of 14.6 based on estimated 2010 income, below the average of 16.6 from the past 55 years.
Leo Grohowski, who oversees $154 billion as chief investment officer at BNY Mellon Wealth Management, says the S&P 500 will climb 5.4 percent to 1,200 by the end of the year, matching the index’s average annual gain since 1928. He’s buying PepsiCo Inc., the second-largest soda maker, because the shares are less expensive than the index and have a higher dividend yield. The Purchase, New York-based company has a price-to- earnings ratio of 17.4 and pays 2.8 percent of its share price in dividends, compared with 1.98 percent for the S&P 500.
“It’s going to be at best a slow and steady commitment of capital to equities,” Grohowski said from Boston. “It’s going to be harder to scratch out attractive returns.
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