Deutsche Bank
Since an eventual tapering of the Federal Reserve's quantitative easing became cemented as a major market theme in May, however, short bets against the stock market have been rising, and flows into long-term investment funds have stalled, resulting in a large amassing of cash in money market funds.
Now, Deutsche Bank believes these trends will reverse, resulting in a flood of cash hitting the stock market to begin 2014.
"Many equity investors are worried given the 27% rally YTD, but we estimate that an incremental $169 billion in pent-up cash and short interest due to taper fears is likely to make its way into equities the next 3-4 months," writes Deutsche Bank strategist Keith Parker in a note to clients. "Indeed, the [first-half-of-the-year] pattern since 2009 has seen cash move out of money markets and into bonds and equities."
Parker runs through a few reasons to believe this will be the case:
Short interest rising since May pulled $30b from US equities. The rise in total short interest (stocks, ETFs, futures) suggests investors are hedging a taper. This "outflow" of $30b from shorting has negated nearly half of the $65b of US equity inflows since May. With short interest relative to market cap currently 0.4% above its bottom band, short covering will see that money flow back into US equities as catalysts pass such as the start of taper.
Taper fears halt inflows into long-term funds, pent-up cash of $139b. In a rare break of a 20y trend, inflows to long-term funds (equity, bonds, hybrid) stalled on taper fears, like the financial crisis and US downgrade. Since May, taper fears have caused bond outflows while equity inflows continued, but the net of the two is zero. With no LT inflows, $139b has piled up in money markets.
H1 pattern sees cash in money markets re-deployed. Each year for the last four years from December to April, investors have moved cash out of money markets into bond and equity funds. We see equities as the beneficiary of cash re-deployment in 2014 as equity inflows have been running at a steady $23b monthly pace since February. Although they have slowed recently, bond outflows are likely to resume on taper fears; but a reset and stabilization in rates higher could see bond inflows with cash rates at zero and curves steep.
Equity positioning not pricing in strong data with taper overhang. Aggregate equity positioning typically tracks the ISM but a large gap has opened up since August; equity beta has fallen toward neutral though data has strengthened, likely reflecting taper fears. Friday's payroll rally also indicates that equities are not fully pricing in the pickup in growth.
Pension rebalancing likely weighed on equities this week. We estimate that each 1% change in pension allocation equates to $31b in rebalance flows. The S&P 500 up 2.8% in Nov implied $43b in potential pension selling, though not all rebalance monthly. Equity inflows and buybacks running at $23b and $33b per month respectively is more than enough demand to offset rebalancing; but markets are a little choppy around the beginning of quarters/months.
Parker says that assuming $120 billion of this "pent-up demand" goes into equities, the S&P 500 could be up 10% to start 2014.