This morning, during the Kansas City Fed’s annual Jackson Hole conference, Federal Reserve Chairman Jerome Powell made a pivotal announcement: “The time has come for policy to adjust.” While Powell didn’t explicitly mention “September,” the message was clear—rate cuts are on the way.
Powell noted that inflation is now on a sustainable path back to 2%, reinforcing the decision to initiate rate cuts: “My confidence has grown that inflation is on a sustainable path back to 2%.” The key question now is what lies ahead. Will the Fed pause after September to assess economic data, or should we prepare for ongoing quarter-point cuts through the rest of the year?
As expected, Powell emphasized a data-driven approach: "The timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks."
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Labor Market Weakness: A Key Factor in Fed’s Shift
Behind this change in policy is the cooling labor market. Powell highlighted that the unemployment rate, now at 4.3%, has been gradually rising over the past year. Though still low by historical standards, it’s nearly a full percentage point higher than in early 2023. Powell expressed concern, saying: “The cooling in labor market conditions is unmistakable… We do not seek or welcome further cooling in labor market conditions.”
With inflationary pressures easing and employment risks increasing, the Fed is now focused on supporting a strong labor market while continuing to stabilize prices.
What This Means for Investors: Will the “Cash on the Sidelines” Flood the Market?
As expected, the market is rallying on the news of rate cuts. But a crucial question remains—will the long-discussed “cash on the sidelines” flood into stocks, triggering a massive market rally?
For the past two years, we’ve heard about a significant stockpile of “cash on the sidelines” waiting to be deployed into the U.S. stock market. The idea has been that once this money floods in, the market could see a major surge.
MarketWatch captured this sentiment back in March:
"A record pile of cash is sitting in U.S. money-market funds. Some Wall Street pundits say this money represents dry powder just waiting to be deployed in the stock market."
While this “record pile of cash” is real, if it moves into the market, the impact might be underwhelming.
To understand why, let’s rewind a bit. Since October 2022, around $1.2 trillion has flowed into money-market funds, pushing the total “cash on the sidelines” to over $6 trillion.
Yes, that’s a significant amount. But focusing solely on this $6.2 trillion figure misses an important detail—the expanding size of the overall stock market. In this context, that $6.15 trillion looks less like a mountain and more like a small bump.
A look at the data reveals this clearly. The white line shows the total amount of this “cash on the sidelines,” which has indeed reached a new high of over $6.2 trillion. But the blue line shows this cash as a percentage of the S&P 500’s value—and here, it’s near average-to-low historical levels.
In simpler terms, while there’s a considerable amount of cash sitting on the sidelines, its potential impact on the market is diluted by the vast size of today’s stock market.
Similar to how a $100K down payment had more purchasing power a decade ago, the $6 trillion in cash reserves would have had a more significant effect on driving up the S&P 500’s gains 10 years ago than it would today.
As analyst Kevin Gordon puts it:
“There might be a lot of ‘cash on the sidelines’ in terms of total money market fund assets, but relative to the size of the equity market, the firepower just isn’t what it used to be… and in fact, cash as a percentage of S&P 500 market cap has been trending lower for the past year.”
It’s also important to note that not all of this cash will flood into the market. Investors typically hold some assets in cash for safety. When looking at historical data, the current ratio of “cash-to-S&P” isn’t significantly higher than it was in 2007.
According to Morningstar Direct, during the peak of the global financial crisis in 2008, assets in money funds accounted for 63% of long-term assets. Since 2011, this figure has averaged around 20%. As of the end of January, U.S. money market levels were at 23% of long-term assets—a level that remains fairly typical, despite the significant inflows seen in 2023.
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It’s important to note that the data referenced above is from January. Since then, the market has climbed roughly 18%, which makes the impact of this sidelined cash even less significant now than it was at the start of the year.
To be clear, a substantial and sustained rally in stocks could indeed be underway. Hopefully, that’s the case. But if such a rally materializes, it will require more than just the injection of this $6 trillion cash reserve to gain serious momentum.
Greater Gains Expected in Small- and Mid-Cap Stocks
If sidelined cash does enter the market, small- and mid-cap stocks could see more substantial gains as investors shift away from the concentrated “Magnificent 7” stocks. While the broader market may benefit, it’s unlikely to be the dramatic rally that some are expecting.
Investors Should Stay Cautious Amid Potential Tax Changes
If you’re sitting on significant investment gains, now may be a good time to consider locking in profits. Vice President Harris, currently leading in presidential race polls, has proposed doubling the capital gains tax and implementing a tax on unrealized gains for the ultra-wealthy. While these proposals are far from becoming law, they could push investors to re-evaluate their portfolios.
If these policies come to fruition, they could prompt wealthy investors to move away from public markets, potentially leading to a selloff and reducing the capital flow into public equities.
The Broader Impact: What This Means for Everyday Investors
Although these proposed tax changes are aimed at the wealthiest Americans, the ripple effects could impact the broader market. A reduction in public market participation and growth investments could have far-reaching consequences, ultimately affecting everyday investors.
Final Thoughts: Rate Cuts Signal a New Era, but Risks Remain
In summary, while today’s announcement signals the beginning of a new rate-cutting cycle, it’s crucial to keep expectations in check. The market’s next moves will depend on how these cuts are implemented, whether sidelined cash enters the market, and how potential tax changes unfold.
As we enter this new rate-cut era, stay vigilant and be prepared for what’s next.
Thank you for joining us on this journey. Remember, the best investment you can make is in yourself. Happy investing!
Together, BuildWealthWise
ChuWei
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