ENDING THE CASH ON THE SIDELINES MYTH

We’ve highlighted the financial punditry’s obsession with “cash on the sidelines” over the course of the last year in attempts to show that there is really no such thing.  The argument from an investment perspective is utterly absurd.  In general, investors like to think that their cash is some sort of fuel for the market that will drive prices higher.  This is easily debunked simply by looking at the transactions at work.  When you buy stocks you are effectively swapping cash with the seller.  It’s that simple.  There is no change in net financial assets.  You merely swapped cash for stock and the seller swapped stock for cash.  The price you arrive at is merely a function of psychology.  Who is the more eager buyer or seller? While there is technically “cash on the sidelines” this amount of cash on the sidelines is relatively stable in any given period. It’s not changing with every transaction as many would have you believe. Therefore, there is no fuel or pile of cash that is just waiting to be injected into the market and drive prices higher.

In terms of corporate balance sheets the argument is equally misleading.  You’ll often hear the financial punditry discuss the asset side of the balance sheet while ignoring the liability side.  There’s all this “cash on the sidelines” just waiting to hire people, merge with other companies, etc.  The only problem is, debt has been surging at the same time that cash levels rise.  We’ve discussed this thoroughly in the past (see here), but Mish at Global Economic Analysis (with the help of Tableau Software) provided a great visual tool today that puts this reality into perspective.  We can see from the following tool that corporate balance sheets aren’t nearly in the excellent condition that most people believe.

Cash on the sidelines? Don’t believe it.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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Comments

  1. Is this a balance sheet analysis or a cash flow analysis?

    If it is balance sheet, then were are the other assets? GE, for instance, has lots of assets: http://finance.yahoo.com/q/bs?s=GE and a positive balance sheet (according to their numbers, anyway)

    If it is cash flow, then we’re comparing a stock and a flow, and that doesn’t work. I’m only interested in operating aspects of debt (debt service costs), and how long existing cash would handle them along with regular operations.

    GE for instance seems to have $153B current assets and $230B current liabilities, but with positive operating earnings and some of their investments tossing off cash, they’re okay on a cash basis, and some of this may actually be cash on the sidelines.

    A stronger argument is that once you apply a tax haircut to any foreign cash that would need to be repatriated to be used (or take it out of the calculations) then net current balance sheet items and look at how much cash they have left vs operations to leave a cushion, then they may not have any investable cash

    But looking at cash vs debt just seems silly to me

  2. imo, this addresses ‘cash and cash-equivalent’ assets on corporate balance sheets, net of liabilities, and is useful in a micro, bottom-up, company-by-company analysis.

    the fact that the ‘cash and cash-equivalents’ isn’t really cash at all, it’s actually ‘already spent’ in securities (CP, Tbills etc), and any redeployment of that money would be predicated upon other funds/cash buying those securities, is the “cash on the sidelines fallacy”. this is a top-down, macro-economic phenomena, and what people are referring to when they point to the myth of money “just waiting to be put to work”. The liabilities (debt which in large-part funds the “cash”) are much less important in this sense – certainly given the timeframe.

    I think they are related, but two separate things.

  3. I guess this is good news and bad news. The good news: if we close the 5 top net asset negative companies and sell off their assets (JPM, Citi, Wells, GE, BoA) we can eliminate almost all moral hazard in the capital markets. Problem with this is the total net debt is 4.5T, where is the rest of the 50T in debt outstanding? Until we know this, a recovery is not possible. Possible guesses include individual mortgages (11T), government (14T), states / private pensions (10T?), CRE / other (15T?).

  4. Comparing a short-term liquid asset with a long-term liability is not helpful. Timing matters. Accounting 101, matching principle.

  5. This analysis is misleading because the huge, levered balance sheets of the financial entities swamp the industrials. Most of the non financial companies I follow do in fact have unusually large amounts of cash. This has been generated in part due to the normal release of cash from working capital due to reduced business activity, and in part because companies have been cautious about commiting to new capex.

    If investors in the aggregate shift their asset allocation from cash to equities, the price of equities will rise, at least in the short run, because the supply in the short run is finite.

      • Still don’t buy the argument, even eliminating financials. Comparing cash with total debt doesn’t really help understand underlying relative liquidity of corporate sector. It is normal for companies to finance their fixed assets with a blend of debt and equity. If you eliminate the financials, the cash for the remaining companies would be greater than or equal to the total amount of debt, which means that companies in the aggregate could pay down 100% of their debt using cash on hand, if they wanted to. That is a highly liquid situation.

        I love your stuff, TPC, but just don’t agree with this item.

  6. This analysis is nonesense. If companies are refinancing their debt at these low interest rates then they can service their debt easily.

  7. Scratching my head.
    My understanding of “cash on the sidelines” is that it’s not related to corporate holdings. It’s the current allocation to the “risk free” portion of the Global Market Portfolio (including govt bonds) by investors institutional and retail.
    The link to “Mish” is just a graphical soundbite. There is no debunking of any myth here. If anything this article is an example of the nonsense that can arise out of anonymous blogs that start linking all over the place especially to something called “Mish”.