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COLUMN-'Full bull' may be further away than it seems :Mike Dolan

(The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own)

LONDON, Nov 20 (Reuters) - Even as the pandemic rages on, vaccine-emboldened investors appear to have already magicked the virus away - raising the prospect that an actual recovery of the world economy next year is greeted with a giant shrug by markets.

Just this week, Bank of America’s monthly survey of fund managers around the world showed cash holdings - hoarded at historic highs this year as a precautionary backstop during the deepest economic shock in a generation - had evaporated this month to levels preceding the pandemic in January.

The survey results suggest portfolios are back at full tilt investing in stocks, bonds and other assets again in the same way they were before COVID-19 hit hard in February.

At 4.1%, cash levels were within a whisker of the sub-4% mark that BoA analysts see as the “full bull”, or maximum investment levels that should reasonably signal caution going forward. Their drop of 1.8 percentage points in just 7 months was the fastest on record.

To be sure, serial vaccine breakthroughs over the past month have seen sizeable re-shuffling of the investment pack, with large rotations away from lockdown favourites in tech and pharma sectors to lagging cyclicals and so-called ‘value stocks’ such as banks, energy and even travel and leisure firms. Exits from long-maturity bonds, gold and the dollar and a steepening of yield curves unfolded in tandem.

The BoA survey findings on cash raise a question about just how much juice is left to lift markets further in 2021 given that a successful vaccine rollout is now effectively assumed and full economic recovery already largely baked into headline asset prices.

But some investment firms have upped their forecasts for major global equity indices for the year ahead.

While the BoA survey may reflect ebullience about the future - with the cash drain matched by similarly upbeat responses on economic growth and the yield curve - data on cash holdings appear to lag that and some reckon the overall supply of money circulating needs more careful examination.

‘FULL BULL’?

On the first issue, U.S. money market fund assets - seen as a reflection of cash hoarding in the investment world - are still some distance from the ‘full bull’.

According to fund tracker ICI, total money fund assets have fallen by about half a trillion dollars since record peaks of $4.79 trillion in May. But at $4.33 trillion, they are still more than a half trillion higher than at the start of the year and about $400 billion higher than the previous record peak at the height of the Great Financial Crisis in January 2009.

On that evidence alone, there appears to be more money waiting in the bunkers than the BoA survey suggests.

JPMorgan, which last week said it expects the S&P 500 to rise another 25% from current levels by the end of next year, uses a more nuanced view of positioning to back up its optimism.

Its fund flow analysts Nikolaos Panigirtzoglou and team reckon dissipating uncertainty around the pandemic, U.S. election and vaccine rollout next year will unlock a greater proportion of central bank liquidity injections and credit creation for investment rather than precautionary cash holdings.

Their model looks at what they call “excess money supply” - or the difference between the expansion of world money supply by central banks and governments and demand for hoarding that extra money as cash, which typically rises in times of great uncertainty like in 2020.

Using a measure of global M2 money supply and the Economic Policy Uncertainty Index as proxies, JPMorgan showed that by July the extraordinary explosion of money supply by global central banks had been “practically wiped out” by cash hoarding.

But as uncertainty and cash demand have ebbed since the summer, this excess money supply has increased again and JPMorgan believes it’s this excess that will provide the fuel for further gains - absent an unexpected and unlikely withdrawal of liquidity supports by central banks.

“Assuming a full normalization by 2021, our excess liquidity measure would rise to levels that are even higher than the previous historical highs seen between the beginning of 2016 and the beginning of 2018,” they wrote.

MSCI’s all-country index rose some 50% between January 2016 and January 2018.

“The implication...would be that a greater portion of the liquidity that has been injected so far as a function of QE and credit creation, would be deployed into higher yielding assets such as equities in the future.”

This, added to the lift to stock valuations and expected future cash flows from floored bond yields and equity discount rates, justifies expectations for another year of double digit stock gains, they concluded.

Not yet ‘full bull’ then.

Of course, uncertainty can rise for many reasons - not just due to a pandemic. And there may be other drivers of cash demand - fear of negative interest rates for one.

But the analysis does show that equities can move higher still if central banks stay easy. And the horror expressed by inflation hawks at spiralling money supply is often wide of the mark, with asset price inflation a more probable outcome yet again as long as worldwide savings build.

by Mike Dolan, Twitter: @reutersMikeD; Editing by Elaine Hardcastle

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