By Mike Dolan
LONDON, Oct 20 (Reuters) - The herd-like dash from cash that has dominated investment behaviour since March may have much further to go than first appears, providing more fuel for this year's blistering global markets rebound.
The exit from U.S. money market funds has been a mirror image of the scramble for those funds when the financial crisis took hold.
But the tendency to date the shift from the collapse of Lehman Brothers in September 2008 is misleading and data shows it was well under way as the subprime bust and credit crunch emerged in early- to mid-2007.
This longer-term perspective of the ebb and flow suggests the unwinding cash-heavy positions is nowhere near over.
And with U.S. money funds still yielding close-to-zero percent -- in line with near-zero Federal Reserve interest rates -- the temptation of higher-yielding fixed income and equity will be difficult to resist. "The big move to cash really took off in late 2007 and we think there is still quite a long way to go before that money gets reinvested," said Jeremy Beckwith, chief investment officer at Kleinwort Benson.
"In the meantime, the central bank taps remain firmly on and in that environment pretty much everything is higher-yielding than money funds."
STAMPEDES
The stampede in and out of U.S. money market funds has defined the global markets landscape for well over a year.
As credit crunch turned to crisis after Lehman's collapse, investors sold assets indiscriminately -- fleeing equity, credit, emerging markets and commodities for top-rated government and cash funds.
Correlations between assets soared, making a mockery of diversification strategies that were designed to limit the downside for portfolios. And with liquidity at a premium, U.S. money funds shone and the dollar soared on currency markets.
Once the economic and market collapse was arrested in March of this year, by a combination of extreme monetary and fiscal stimulus from governments around the world and hopes for an inventory-led bounce in global manufacturing, the whole money flow went into reverse. The bounceback has been just as violent.
Equities, credit, emerging markets and commodities surged in tandem and the dollar's gains were rapidly unwound.
EBB AND FLOW
The best proxy for this spectacular herding has been U.S. mutual fund data showing net flows to and from money funds.
Fund tracker EPFR estimated last week that by Oct 14, some 94 percent, or $396 billion, of the net flows to U.S. money market funds in 2008 had already exited those funds this year -- seemingly completing the stressed-money cycle.
The direct results have been obvious. Since the start of the year, world equities are up over 30 percent; emerging markets are up 70 percent; commodity prices are up 21 percent; and credit default swap premia on investment-grade corporate borrowers have halved.
The dollar, of course, has lost about 7 percent against a basket of the world's most traded currencies.
Correlations remain sky-high, meantime. The link between the euro/dollar exchange rate and world equities, on a 25-day rolling basis, is almost a perfect one-for-one. The equivalent link between Wall St stocks and emerging markets is more than 0.8, while world stocks and commodities is about 0.75.
So the questions are whether this whole night-and-day scenario is nearly over and whether we will soon see a return to more "normal" investment patterns -- characterised by more idiosyncratic market moves and lower correlations.
The data and many analysts say not.
TWO-YEAR CRISIS
While a bald mapping of 2009 onto 2008 money fund flows suggests normalisation may be afoot, judging the length of the "crisis" is key.
For a start, money funds were attracting heavy net flows well before the Bear Stearns and Lehman shocks in spring and autumn of 2008, and subprime mortgage woes and the resultant credit crunch were seeing money go to ground from early in 2007.
EPFR reckons U.S. money funds that report weekly took in a net $191 billion in 2007 as a whole.
That suggests that if the global recovery continues and money funds reverse all the crunch-related flows of the last two years, then the unwinding is at most only two-thirds through.
What is more, these numbers are based on just U.S. data and it is likely the more opaque European and Japanese money market funds have similar flows left to unwind.
ZERO THE NEW BENCHMARK
But, perhaps most powerfully, analysts argue that zero-yielding cash has become the new benchmark for global investors -- forcing investors out along the curve.
Strategists at JP Morgan this week said the most immediately powerful investment theme of the moment was "asset reflation" -- or the pain of zero return on cash that is pushing investors into other assets with positive yields. Significantly, they doubt it should extend to commodities, which have negative yield.
Using estimates of a risk/return trade-off in the United States, they show the steady flight from cash reducing returns available for a given level of risk or volatility but that this return was still double its historical mean.
"The flight out of cash is set to continue, even if there are no further upside surprises on the economy," they said in a note to clients. "The low return on cash has become the new benchmark for value and should keep pushing other values up." (Editing by Stephen Nisbet)