There is a persistent headline out there about “cash on the sidelines”. For a quick explanation of the argument, here is a quote from perma-bull Louis Navellier:

There’s more cash available to buy shares than at any time in almost two decades, a sign to some of the most successful investors that equities will rebound after the worst year for U.S. stocks since the Great Depression.

The $8.85 trillion held in cash, bank deposits and money- market funds is equal to 74 percent of the market value of U.S. companies, the highest ratio since 1990, according to Federal Reserve data compiled by Leuthold Group and Bloomberg.

…Still, the fact remains that stock prices are low and once a rally starts, there’s plenty of fuel to carry it for a long time.

The argument goes, as long as there is cash on the sidelines, that cash will be used to rush into the stock market propelling prices higher.

Let’s do a little thought experiment… Suppose I am one of those people with cash on the sidelines with $1000 in cash in my brokerage account. I decide to buy $1000 of INTC with my cash, giving someone $1000 for about 67 shares of INTC. The counter-party on the trade now has 67 fewer shares of stock, but also has a new $1000 in cash in his brokerage account.

The same thing happens in the other direction… When I sell the 67 shares of INTC, I get more cash in my brokerage account, but the person who bought the shares from me previously had the same amount of cash “on the sidelines” in his account.

Wait a minute, there’s still $1000 in “cash on the sidelines” just like before the stock got bought… but instead of being in my brokerage account, it’s now in that other guys… What gives?

The deal is that the amount of cash on the sidelines will always remain the same. The higher amount of cash on the sidelines right now is a byproduct of Fed easing and attempts to increase the money supply more than any money “leaving the market”.

The lesson here is obvious… the next time you hear someone arguing that the market has to go up because of the amount of cash on the sidelines one of two conclusions is possible: the person is uninformed, or they’re selling something. In the case of Mr. Navellier, I believe he’s guilty of both faults — he’s ignorant of the dynamics at work as well as trying to sell his long-only investment newsletter.