NELSON: Cash on the sidelines | Notice

One of the most surprising results of last year’s pandemic has been increased household income and savings. Initially, no one would certainly have predicted this. However, thanks to the government’s fiscal stimulus in the form of direct payments and improved unemployment benefits, overall household balance sheets have improved significantly. Of course, this didn’t apply to everyone, just on average.

Many financial experts saw this increase in household wealth as “money on the fringes” or a source of funds that could be used to buy financial assets and drive up prices. At first glance this makes a lot of sense and a lot of that money was probably invested in financial instruments last fall and early this year when we saw the stock market reach new highs.

However, while household savings are still on the rise, we have not seen the same strength in financial assets in recent months. The big question is whether this is just a lull and if the excess liquidity will always end up in stocks and bonds, or is there something else?

There is an axiom in the financial industry that says “Don’t fight the Fed”. The reasoning behind this can be summed up in one word: liquidity. When there is a lot of liquidity in the economy and the markets, it tends to support the prices of financial assets. When liquidity runs out, that support may disappear. Liquidity can be provided in several ways: low interest rates, reduction of bank reserve requirements, stimulus payments, tax breaks, etc.

We’ve certainly seen a lot of liquidity this cycle, but it can still be difficult to determine how that might affect risky assets like stocks. One of the best ways we’ve found to help us gauge this is to look at household liquidity relative to stock prices. One of the reasons for this is that even though liquidity is high relative to history, if the stock market is also high relative to history, the amount of money available to fuel stocks might not move. the counter at these higher levels.

Here we define household liquidity as things like checking accounts, savings accounts, CDs, savings bonds, money market funds, etc. (basically items that could quickly be turned into dollars and moved elsewhere) minus debts such as loans and credit cards. debt. And while this has seen an increase over the past year, when we compare it to general stock market usage and an index like the Wilshire 5000 Index (this looks at all publicly traded companies in the US), we find that stocks have risen a lot more.

In fact, when we take the household liquidity ratio in the stock market, we find that this measure is close to an all-time low. It was not lower until the late 1990s. Historically, at these levels, stocks have struggled to provide much return.

So yes, there is certainly a lot of liquidity in the economy right now and we could see an increase in consumer spending as a result. But the idea that this marginal liquidity can have a significant impact on stock prices does not seem to be confirmed in historical data.

While every cycle is different, and it’s just an almost endless number of metrics that investors have, I think it’s important to understand this in our current situation. While I totally agree with ‘Don’t fight the Fed’, the ability to drive up asset prices with liquidity appears to be weakening. The key will be to watch for signs of liquidity coming out of the system, such as rising interest rates, and making sure you have a risk management plan in your portfolio.

1Source: Ned Davis Research – Households’ Free Liquidity (Non-Equity Liquid Assets Less Liabilities) / Wilshire 5000 Total Stock Market Index

Disclosure: Investing involves risk. Depending on the types of investments, the risks may vary. Investors must be prepared to bear losses, including loss of capital. The indices mentioned are not managed and cannot be invested directly. Past performance is no guarantee of future results. Examples are hypothetical and for illustration purposes only. Rates of return do not represent any actual investment and cannot be guaranteed.

Titles via Cambridge Investment Research, Inc., FINRA / SIPC member. Advisory Services Through Cambridge Investment Research Advisors, Inc. Cambridge and NelsonCorp are not affiliated.

David M. Nelson is President and CEO of NelsonCorp Wealth Management.

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