‘Japanese savers are poised to pump $690 billion into stocks to benefit from new tax breaks as the government tries to avert a retirement cash crunch in the nation with the world’s oldest population and lowest interest rates.‘ – Bloomberg News
That’s a heck of a lot of cash.
In fact, it’s so much that it’s the equivalent of 21% of the Japanese market’s entire market capitalisation.
With that much cash ready to pour into the market, it’s inevitable that stock prices will go up…or is it?
As a stock market bull our answer may surprise you…
Unless you open our daily letters to you and then ignore everything we have to say, you should know by now that we’ve put a 7,000 point price target on the S&P/ASX 200 index.
That’s about as bullish a forecast as we’ve seen anyone make for the Australian market. But as we always like to say, you shouldn’t expect the market to climb in a straight line. There will be bumps and periods of mind-numbing boredom along the way.
In the next few weeks we’ll lay out our position on why and how the market will advance to 7,000 points between now and 2015. The first target is for the main Aussie index to hit 6,000 points by early next year.
But that’s for another day. First up, what about all this cash ready to flood the market?
Beware the ‘Weight of Money’
We have no doubt that central bank money printing has boosted stocks. In our mind it’s undeniable. You only have to look at the charts of the US, UK, and Japanese stock markets to see the impact:
Source: Google Finance
The US S&P500 index is up nearly 150% since the March 2009 low.
So, if central bank money printing can boost stocks, doesn’t it make sense that $690 billion worth of cash can boost the Japanese market? And what about all the cash supposedly sitting on the sidelines in the Australian market?
This is the ‘weight of money’ theory or the ‘Money Torrent’ as we prefer to call it. The idea is that there’s so much cash ‘on the sidelines’ that if it begins flowing into the stock market, the price of stocks will soar.
It’s a nice theory. And we don’t entirely disagree with it.
However, we have one caveat when it comes to the ‘Money Torrent’, it’s this: don’t forget price.
When it comes to the ‘Money Torrent’, most of those who back the theory completely ignore the impact of price. Yet price is arguably the most important factor for stock markets.
It’s price that makes an asset attractive or unattractive to investors. In order for an investor to pay a specific price for a stock (or any other asset) the investor needs to believe the price will rise or that the company can continue to pay or increase a dividend.
That’s because investors will always look at an investment in relative terms to another investment. If a stock is only paying a 4% dividend yield with no prospects of stock or dividend growth then the investor will most likely prefer the cash investment that’s paying (say) 5%.
Investors Won’t Buy Stocks if There isn’t Any Value
So, the ‘Money Torrent’ on its own isn’t enough. We know that because we heard the same ‘Money Torrent’ arguments during the last bull market from 2003 to 2007.
The story went that with 9% of workers’ salary pouring into superannuation every year it would ensure prices kept going up. Plus they said there wouldn’t be enough shares on the market to absorb this flow of funds.
However, those proponents forgot a couple of things. They forgot about price, and they forgot that companies can issue more shares in order to raise capital and expand. Like the housing market, it turns out there wasn’t really a shortage of shares.
That much was clear as the market topped out in 2007 and then fell 50% over the next year.
Even 9% of everyone’s wages going into investments couldn’t stop the market falling. That’s because investors didn’t have to buy shares. They looked at stocks relative to other investments and decided that stocks weren’t as attractive as (say) cash.
Our old pal Greg Canavan made this case over at the Daily Reckoning last week in response to billionaire investor Warren Buffett’s claim that the market looks fairly valued. Greg told readers:
‘Unlike your standard fund manager, who has a mandate to be fully invested at all times (or maybe has the discretion to go to a whopping 5% cash) [Warren] Buffett can do what he likes. If he can’t find value in the stock market, he holds cash and waits…
‘So is Buffett’s $49 billion cash hoard telling us a market peak is at hand? No, but it’s telling you there is a distinct lack of value in the market. And Buffett has pretty good form in equating lack of value with market tops. He cashed up in 1999 too, just six months or so before the market peaked in March 2000.‘
Bottom line, investors don’t have to invest in stocks. And if our old buddy Dan Denning is right, neither should they. Dan says the market is on the verge of seeing its first recession in 22 years.
Any investor who ignores that warning is asking for trouble.
That said, the ‘Money Torrent’ argument isn’t entirely without merit…
Don’t Ignore the Warnings, But Stocks Could Still Climb
Look, don’t get us wrong, we’ve played the ‘Money Torrent’ game hard over the past five years, banking on central bank money printing boosting stock prices.
But as we mentioned above, the market doesn’t go up just because there’s a lot of money on the sidelines waiting to flow into it. The market goes up because investors believe it represents good value.
However, despite what the investment pros may think, if investors believe the market is good value and that the ‘Money Torrent’ will boost stock prices then that could provide an extra boost to stocks.
We think back to the market in 2005 and 2006. By this point the market was already half-way to reaching its 2007 peak (although of course investors didn’t know that at the time).
After the market had doubled from the 2003 low, there were plenty of investors who thought the market had run up too far…and that the next move was down.
That proved to be an important lesson for investors – stock prices can go higher (and lower) than anyone expects. Even when valuations looked stretched, the market can still draw investors into buying stocks.
This is a big reason why we believe stocks will continue to rally through the end of this year, even if they take a pause in October. But despite our bullishness you shouldn’t ignore the warnings.
The question is whether a recession would have a negative impact on the market or whether it would give the Reserve Bank of Australia the excuse it needs to cut interest rates further…and perhaps begin a money printing program on a par with overseas central banks.
Cheers,
Kris+
Special Report: Are You Waiting for a Real Estate Crash That Isn’t Going to Come?
