What a Spike in Cash Holdings Could Mean for Stocks

For the first time in two years, there's been another jump in cash allocation

Senior Quantitative Analyst
Aug 10, 2022 at 7:00 AM
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About a year ago, I wrote an article on investor asset allocations according to a monthly survey by the American Association of Individual Investors (AAII). At that time, the allocation to stocks was high while the allocation to cash was at one of its lowest levels ever. The data showed high stock allocations and low cash allocations tended to precede stock market underperformance. It makes sense that if investors are fully invested, it leaves little sideline cash to push the market higher. The good news is that things have changed. Stock and bond allocations have fallen over the past year as investors are moving money into cash. The survey shows over 20% of portfolios are now in cash. Below, I look at the historical implications. 

iotw chart 1

Investors Holding More Cash

I find the chart of cash allocations interesting. Investors were not holding much cash in the late 1990s during the tech boom. It seems the tech bust caused a paradigm shift where 20% became the minimum cash allocation. For some reason, unlike after the tech bust, investors reacted differently to the financial crisis. Shortly after stocks bottomed in 2009, investors were allocating less of their portfolios to cash. Twenty percent became the maximum, except for a few spikes above it. And for the first time in two years, we have another spike in cash holdings.

iotw chart 2 aug 9

We have data on the AAII Asset Allocation Survey going back to 1987. The first sub-20% cash allocation reading was in 1995 in the middle of the tech boom. In December of 1996, the allocation went above 20% after spending four months below that level. The table below shows all times the cash allocation moved above 20% after spending at least four straight months below that level.

There are only six prior signals that led to bullish stock returns. The recent signal is off to a good start too. After these months in which the cash allocation moved above 20%, the S&P 500 Index (SPX) gained an average of 5.6% over the next three months with five of six returns positive. Over the next year, the index has averaged a 20% gain with, again, five of six returns being positive. The last signal occurred at the most uncertain time of the Coronavirus pandemic, and it turned out to be a great buying opportunity. The two signals prior to that, in December of 2018 and January of 2016, were also good longer term buying opportunities with the S&P 500 gaining 28.9% and 17.5% respectively over the next 12 months.

Stocks have shown some signs of life over the past several weeks. According to this survey, investors are sitting on some cash. If the market continues to climb, that cash is going to look less appealing. If investors are close to capitulating, it's good to have your money in first.

iotw chart 3 aug 9

 

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