Retail investors are in no rush to join the latest stock market rally

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US stock markets roared back to life at the end of 2023. Both the S&P 500 and the Dow Jones Industrial Average are up 16 per cent since late October, hitting new records last week. The tech-heavy Nasdaq Composite, which is particularly vulnerable to a rapid rise in borrowing costs, is only 5 per cent away from its all-time high.

Optimism that the Federal Reserve is done raising interest rates is fuelling the gains. Yet not everyone is rushing in. For many retail investors, cash is still king.

Net purchases of US equities by individuals totalled $11.7bn in the 10 trading sessions to January 16, according to data from consultancy Vanda Research. That compares with a peak of $17bn in the comparable period last February when the S&P 500 was 18 per cent lower.

Small investors have plenty of reasons to stay on the sidelines for now. Cash and cash-like instruments — such as high-yield savings accounts, certificates of deposit and money market funds — all continue to offer yields not seen in years.

An index of the 100 largest money market funds run by Crane Data, which tracks the industry, shows average yields currently stand at 5.16 per cent.

More than $1.1tn flooded into US money market funds last year, according to the Investment Company Institute. Inflows have continued this year, with total assets in the industry hitting a record $5.97tn this month.

Some brokerages have come to rely on “cash sweeping” (of uninvested cash into savings or money market accounts) as a source of cheap deposits. For them, investor caution is a double blow. Not only are they earning less from trading commissions, they are also making less net interest revenue.

More trading would certainly help Charles Schwab, which needs to bring in new cash to replace the expensive temporary borrowing it took on to ride out last year’s regional banking crisis.

Instead, it said the number of daily average trades fell 4 per cent year on year during the fourth quarter. This is despite the financial services company adding 3.8mn new brokerage accounts last year.

By contrast, the amount of cash parked in Schwab money market funds jumped 70 per cent to $477bn during the fourth quarter. Schwab earns a 0.26 per cent fee on these funds. But it is paltry compared to what it could make by putting clients’ money to work itself in the current high-rate environment. Schwab could pay more to get clients to keep their uninvested cash in their brokerage accounts. But this will push up its funding costs.

While interest rates are seen to have peaked, policymakers are in no rush to bring them down. Assuming three quarter-point rate cuts this year, Fed fund rates would fall to between 4.5 and 4.75 per cent by the end of 2024. That prospect may not be enough to get retail investors to jump back in.