Cash Piles Grow in Bank Deposits and Money-Market Funds

Admittedly, the headline should read "Finance Bloggers Desperate for Material on Slow News Day," but this Bloomberg story on growing cash piles is the best I could come up with for interesting reading today.  According to Federal Reserve data complied by Leuthold Group and Bloomberg, $8.85 trillion dollars are currently held in cash, bank deposits and money-market funds, equal to 74% of the market value of US companies.  This represents the highest ratio of cash to market value since 1990.  Apparently, the eight previous times that cash peaked compared with the market capitalization the S&P 500 rose an average 24% in six months.  Note, however, that the rise in the S&P is dependent on knowing the actual peak, which makes this bold observation less meaningful.  The statement is similar to saying "100% of the time after the S&P reached its peak, it declined."  So while 74% seems high, who says this is the peak and that the ratio won't go to 120%?  

In theory, investors at some point will grow weary of earning 0% returns on their money, and start to dip their toes back into higher risk fare.  However, if we become trapped in a deflationary spiral, investors will have little incentive to part with their cash and return to the stock market.  So the big question remains:  Are we in for a period of deflation, as treasury yields suggest or will another bubble be stoked by the Fed's zero interest rate policy?  I am leaning towards the latter, albeit after a brief period of deflation due to asset prices over-shooting to the downside.  While I believe that some assets have already suffered significant corrections, many have not, as I will discuss in more detail in my forthcoming posts on predictions for the new year.  Certainly, the inflation versus deflation argument stands to be one of the most important of 2009, as the answer will determine if and when investors decide that stocks are worth the risk again.