The excessive levels of cash held in money market funds is poised to fuel a significant rally in risk assets this year, according to Principal Asset Management.
In the firm’s quarterly asset allocation outlook, it reflected on how rising interest rates has led many individuals to hold money market funds rather than equities or bonds for their above-average returns and greater stability.
Almost $6 trillion is currently held in these types of funds, the firm said, and research by Stockspot in October found Australian investors drove more than $1.6 billion of net inflows towards cash ETFs over the past year.
“The significant pool of cash currently being harvested in money market funds is poised to fuel a significant rally in risk assets, offering investors an opportunity to capitalise on improved sentiment and market dynamics,” Principal said.
“The long-awaited downturn should arrive and depart without leaving too much destruction, inflation should continue to decelerate and, most importantly, the Fed is likely to open the door to rate cuts, reducing the attractiveness of money market funds.”
Equities are likely to rally in the second half of the year, particularly those in the US, with 2024 set to be a year of two halves of economic headwinds in H1 and economic recovery in the second.
“While the first half of 2024 may prove choppy, investors with longer-term horizon should identify good value opportunities and position for an equity market rally in H2.
“In H1, elevated earnings growth expectations will likely be tested by slowing consumer demand as excess savings erode, the labour market softens and the delinquencies rise. Margins will also be under pressure given less opportunity for price padding in the lower inflation environment. These headwinds may challenge the strong equity narrative.
“However, equities should see renewed resurgence in H2. Not only will a recovering US economy imply support for earnings growth, but contained price pressures mean the Fed can begin monetary easing.”
Rates have been rising globally in the past 18 months with the Reserve Bank of Australia (RBA) interest rate currently sitting at 4.35 per cent, although it was held at the last meeting in December. Industry commentators expect Australia will be the last major market to embark on monetary easing, behind Europe and the US.
Prompted by the RBA pause, there is evidence from State Street and Bank of America that cash weightings are already starting to fall. The State Street Institutional Index found cash allocations in December fell by 0.3 percentage points to 19.9 per cent but still sit at an overweight position.
Meanwhile, Bank of America’s global fund manager survey said investors were holding the lowest weighting to cash in December since April 2021 with a net 3 per cent overweight.
Click here to read Money Management’s feature on the growth in cash ETFs.
