Money flows where it’s treated the best

I’m not a big believer in market truisms, since many of them
wither when the bright light of empirical testing shines upon them. But there’s
one maxim that I’ve always been fond of, and that has stood up over time:

“Money flows where it’s treated the best.”

That phrase is usually bandied about in relation to interest rate differentials
and foreign exchange, but it’s equally applicable when looking at any asset

Because investors usually shovel money into assets that treat them well, meaning
high potential reward with low probable risk, we often see marked shifts in
behavior when assets show an extreme move.

An example of this is short-term interest rates. According to the Federal
Reserve, the yield on 3-month Treasury Bills went from under 1% in the spring of
2004 all the way up to 5% last month.

That’s a heck of a jump for a “risk-free” investment, and investors are taking
notice. A couple of months ago, broker Charles Schwab announced that they were
seeing their clients consider “cash” an asset class once again…when was the last
time they were able to say that?

Fund managers are no different than anyone else — when they see a risk-free
security yielding 5%, then they’re going to shift more client money that way,
instead of into stocks which yield 7% but with a whole lot more risk and

So historically, when short-term interest rates rise, we’ve consistently seen
fund managers shift more and more client assets into cash and other liquid

Until now.

Over the past couple of years, short rates have jumped significantly higher as
noted above. But the amount of cash that fund managers are holding (as a
percent of total assets) has actually decreased from 4.4% to 4.1%.

This is abnormal behavior, and it has reached an extreme. The chart below shows
mutual fund cash levels, after adjusting for the prevailing level of short-term
interest rates. The most recent data suggests that funds are holding about 3%
less cash than they “should” be given where interest rates are, a deficit that
has been matched in extreme only by January 1981 and February 2000 over the past
56 years.

On the chart, I’ve marked other times when cash reserves became ominously low.

There are some valid reasons why we might be seeing a new regime of lower cash
balances now, such as the proliferation of index funds, the backlash against
managers who try to time the market and the introduction of futures and options
markets, among others. But it’s hard to argue that the current situation is
anything but concerning from an historical point of view.

Jason Goepfert

Jason Goepfert is the founder of Sundial Capital
Research, Inc. and Editor of, a leading website for the unique and practical
application of behavioral trading to the stock and bond markets. The site has
subscribers in all 50 states and more than 50 foreign countries, including
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