Will Low Rates Push Savings into Stocks?

By TOM PETRUNO

June 3, 2001 12 AM PT

TIMES STAFF WRITER

The Federal Reserve’s dramatic cuts in short-term interest rates this year have had one overriding goal: to reduce the cost of credit for struggling companies and consumers, thereby lessening the chances that an economic slowdown will become a recession.

But the Fed can’t affect lending rates without also affecting savings rates. And by pushing rates on money market funds, bank CDs and other short-term accounts to seven-year lows, the central bank seems to be playing chicken with millions of American savers.

Fed Chairman Alan Greenspan might as well be telling savers: “How much pain can you take? If you don’t like these low yields you can always move your money into something higher-risk and potentially higher-return--say, stocks, or long-term bonds.”

In fact, when Wall Street pros tally up the reasons to be bullish about the equity market these days, high on the list is the expectation that people will soon begin to shift significant sums from short-term accounts to stocks rather than settle for dwindling yields.

It’s a logical assumption. But will it happen in the real world?

Recent experience suggests it may not be wise to bet that short-term savings will serve as a great pool to reliquefy the stock market. Data show that most of the dollars placed in short-term accounts in the 1990s tended to stay there.

Now, whether the stock market needs that cash to rally is another matter. Americans in the last decade found enough money to boost their short-term savings and pump record sums into stocks. It could happen again.

Still, it’s no wonder Wall Street is salivating at the prospect that the Fed is making short-term accounts wholly unappealing.

Money market mutual fund assets now total $2.1 trillion. That compares with the $3.7 trillion investors have in stock mutual funds, according to the Investment Company Institute, the funds’ chief trade group.

There is an equally large cash hoard in short-term accounts at banks. The latest Federal Reserve data show that savings accounts at banks--mostly so-called money-market deposit accounts--hold about $2 trillion.

What’s more, small CDs at banks--individual CD accounts worth less than $100,000--total about $1 trillion. That includes CDs of all maturities, but many savers have tended to favor shorter-term certificates, meaning those maturing in one year or less.

The stock market overall still is a far bigger animal than the short-term accounts combined. The U.S. market’s total value is more than $12 trillion.

Even so, a shift of just 10% of the $5.1 trillion in short-term accounts to the stock market would mean an injection of $500 billion. That would dwarf the record $140 billion in net new cash that stock mutual funds took in during the first quarter of 2000--which helped power the Nasdaq market surge that was the last hurrah of the 1990s bull market.

But history isn’t on the side of market bulls who believe that an avalanche of cash is headed from short-term accounts to stocks soon.

“I read those same comments [from Wall Street] and just shake my head,” said Brian Reid, an economist at the Investment Company Institute who has studied fund investors’ habits.

The last time short-term rates were this low--averaging under 4% for seven-day money market fund yields--was 1994, just as the Fed began raising interest rates after keeping them at rock-bottom levels in 1992 and 1993 amid slow economic growth.

Money market funds had net cash outflows in 1992 and ‘93, but the totals were minimal, amounting to less than 3% of fund assets, ICI data show.

Savers did, however, pull a substantial sum from bank CDs in 1992 and 1993: Small-CD totals fell from $1.07 trillion at the end of 1991 to $782 billion by the end of 1993, a drop of 27%.

Where did that CD money go? Some of it may have flowed to the stock market. But because CD owners tend to be hard-core income-seekers, experts believe much of the CD outflow sought higher yields in Treasury, corporate and municipal bonds in the early ‘90s.

Indeed, bond mutual funds took in a net $140 billion in new cash during 1992 and ‘93, ICI data show.

At the same time, some CD owners may simply have opted to keep their savings liquid rather than lock it up at lousy yields. Although CD totals tumbled from 1991 to 1993, assets in bank savings accounts rose by $175 billion.

As the Fed raised interest rates in 1994, money began to flow back into CDs and into money funds.

In the late 1990s, as the stock market soared, it seemed inevitable that short-term accounts would be raided for Wall Street’s benefit.

Yet money market funds saw no net outflow of cash in the late ‘90s, ICI data show. Though individual investors contributed less to money funds in that period than to stock funds, there was no wholesale rush to cash out of short-term accounts in favor of stocks.

Likewise, assets in bank short-term accounts continued to rocket during the late 1990s.

Of course, there’s a lot happening under the surface of those account totals. Millions of individuals and businesses are putting money in, and taking it out, on a daily basis. Therein lies the hazard of generalizing about what people do with their cash: There are plenty of exceptions to any seeming rule.

Nonetheless, the totals at least make the point that short-term savings didn’t serve as a reservoir drawn down for the stock market’s good in the late ‘90s.

Reid notes that, though people and businesses use short-term accounts for many purposes, a core role the accounts play is one of safe haven: They hold cash that isn’t meant to be put at risk of loss.

So although Wall Street may view short-term accounts as pools, Reid prefers to see them as “silos,” often storing capital that may never be tapped for other uses--even if the returns on that capital are minimal.

Given the buildup of money fund assets during the bull market’s heyday, Reid said, “If there wasn’t a flood leaving money funds [for stocks] in that period, people aren’t going to leave because of the drop in yields” this year.

The experience many investors have had in the equity market over the last year also may keep most assets in short-term accounts securely anchored there.

The worst stock market losses since at least 1987 taught new investors a painful lesson about the nature of risk in equities--and reminded those who had forgotten.

Also, people who ignored financial planners’ admonishments to always keep a cushion of emergency funds in safe short-term accounts may now be taking that advice to heart, amid rising layoffs.

The 3% to 4% yields available today on short-term savings accounts won’t make anyone rich, and those accounts aren’t now, and never will be, the right place for true long-term investment dollars.

But if the Fed means to inflict pain on short-term savers, most may not yet be ready to cry uncle: Short-term yields may be paltry, but at least they’re positive--whereas the average stock mutual fund still is down 4.8% this year.

Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, go to https://www.latimes.com/petruno.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Cash Mountain

Money market mutual fund assets soared in the 1990s, even as investors shoveled record sums into stock funds.

Money fund assets in trillions, year-end totals and latest

May 31: $2.1 trillion

Source: Investment Company Institute

Money in the Bank

Since 1990, savers have increasingly favored short-term bank accounts--mostly so-called money market deposit accounts--over certificates of deposit.

Assets in Billions

Bank savings deposits

April 30: $1,993