What happened in the past when cash reached these levels?

• In September 1974, cash on hand reached $604.5 billion, representing a record 1.21 times the U.S. stock market’s capitalization. That preceded a 31% gain in equities between October 1974 and March 1975.
• In July 1982, just as a 20-month bear market was ending, cash as a percentage of the U.S. stock market’s value rose to 95%. The S&P 500 began a six-month, 36% advance. According to Bloomberg, the eight previous times that cash peaked compared with the market’s capitalization, the S&P 500 rose an average 24% in six months.

This time, of course, it didn’t take nearly as long for the market to rally.

Still, the greatest appreciation so far has been in smaller stocks. That’s normal in an early bull market. But if the bull market continues, the big, blue-chip stocks are likely to lead the market higher for two key reasons:

• First, there is still over $8 trillion on the sidelines earning next to nothing in short-term deposits. Investors tip-toeing back into the market are likely to gravitate here since these stocks are the safest.
• And then there is the growing influence of cash-rich sovereign wealth funds…

Sovereign Wealth Funds – The Financial Assets of a Country

Sovereign wealth funds are the financial assets of a country – usually part of the national savings – that are owned and organized into a state-controlled fund and put to work to earn a higher return on investment.

(Sovereign wealth funds are not the same entities as foreign exchange reserves, which are often used for short-term currency stabilization and liquidity.)

In the past, most countries put their liquid assets to work in foreign currency deposits, government bonds or gold. (The hard-working Japanese and Chinese, for example, have kept our interest rates low by maintaining a steady appetite for U.S. Treasury obligations.)

But with the dollar relatively weak and interest rates on Treasuries near record lows, U.S. government bonds are not generating the kind of returns you write home about.

So world governments are slowly moving money into global equity markets. And the sums involved are fairly staggering.

Sovereign Wealth Funds Control More Than $7 Trillion…

According to The Economist, sovereign wealth funds already control more than $7 trillion today. The exact amount is impossible to ascertain due to lack of transparency.

But China, Saudi Arabia, Singapore and the United Arab Emirates alone are known to control more than $2 trillion. And more money is being allocated to these funds all the time.

What does this mean for you as an investor?

Expect to see cash coming off the sidelines to accumulate shares of the largest, most liquid firms around the globe. Quite frankly, they are the only companies that can easily absorb buying on this scale.

For example, take a look at the Dow Jones Global Titans Fund (NYSE: DGT). It holds the world’s 50 largest publicly traded companies.

World-Class Diversification in a Blue-Chip Portfolio

When you buy this cheaply valued blue-chip portfolio, you’re getting world-class diversification.

Companies like:

• Exxon Mobile,
• IBM,
• Proctor & Gamble,
• Wal-Mart,
• Coca-Cola,
• Nestlé,
• Toyota Motor,
• Roche Holdings,
• Samsung Electronics

… Are just a few of the names that are major holdings of the DGT fund.

These firms will almost certainly be an early stop for U.S. investors who get frustrated with low yields and start venturing back into the game.

These same companies are a natural home for sovereign wealth funds – and the growing trillions they control.

History shows that cash on the sidelines always grows itchy with time. The Dow Jones Global Titans (NYSE: DGT) is a good way to take advantage of it – ahead of the crowd.

Source: Sovereign Wealth Funds: $7 Trillion Reasons to Stay Invested

An article in the English-language of the German der Spiegel newspaper reported that the billion-dollar Sovereign Wealth Funds (SWFs) have lost up to 25% of their value – depriving the markets of a major cash source.

For those of you unfamiliar with SWFs, they are state-owned investment houses whose charter is to protect any budget surplus with prudent investments. The commodity boom of the past few years has filled the coffers of SWFs rich in raw materials such as oil, natural gas and metals.

Thought to be impervious to market swings, SWFs were held up as secretive groups with an uncanny knack for finding the best investments. That reputation blew up, however, when SWFs started to prop up Merrill Lynch, Citigroup and other big investment banks that ultimately lost a bundle.

These once-infallible mega-investors are now liquidating as they try to save their butts. In the process, money that they would have allocated to major investment projects such as commercial real estate, banking, oil exploration and other cash-intensive endeavors is simply going away.

The implications for both emerging and industrialized markets are profound, fueling speculation that the economic malaise could last longer than previously anticipated.

The article in der Spiegel reports that Norway’s $300 billion Government Pension Fund-Global, was down 7.7 percent in the September quarter. It was the worst performance in the 18-year history of the fund, which invests Norway’s oil revenues.

All told, SWFs have lost 18% to 25% this year alone, according to der Spiegel story. That could mean some $700 billion in cash has been taken out of the global investment pool.

The Abu Dhabi Investment Authority, perhaps the world’s biggest SWF, may have lost up to one-third of its $900 value, the German newspaper said. Things were bad in other Mid-East SWFs as well.

The Kuwait Investment Authority lost about 30% of its $250 billion reserve, although $50 billion of those losses may have been recouped with a new infusion of oil money. The Qatar Investment Authority is thought to be down 20% in 2008.

As the recession continues, where will new money come from? Well, it seems that taxpayers are picking up where the oil sheiks left off with bailout campaigns going on all over the world.

The withdrawal of SWFs from American markets means that taxpayers must pick up the slack to the tune of $700 billion (or more). It could also mean that the disappearance of this source of capital could further delay any sustained recovery.

The Persian Gulf SWFs, in particular, are redirecting their funds to domestic projects, where they see a higher payoff, according to various news sources.

Dubai International Capital is turning its attention the Middle East, China and India.

Investment funds in Kuwait, Qatar, Dubai and Abu Dhabi are revamping their investment strategies after losing billions of dollars buying shares in Western companies.

The Kuwait Investment Authority (KIA) recently shifted $4 billion from Western markets into its own bourse. At the same time, the Qatar Investment Authority has begun a bailout of local banks. Dubai International Capital (DIC) is concentrating on emerging markets. And there are reports that the $700-billion Abu Dhabi Investment Authority is investing more in to local markets.

Sameer al-Ansari, the chairman and chief executive of DIC, was quoted as saying that the balance of economic power was shifting east and that the fund’s investments would follow.

Samba Financial Group, a Saudi Arabian bank, said that the Gulf’s wealth funds were likely to lose about $190 billion this year, effectively flattening profits gained from the high price of oil.

If you’re the kind of investor who likes to follow the money, the SWFs are showing that China, India and other emerging economies with low debt on the books are the places to be. But as we’ve all seen, the SWFs have been painfully wrong before.

The real lesson we’re seeing from the meltdown and the SWF shift of capital is this: Just because you’re fabulously wealthy doesn’t mean you’re innately smart.

This from Taipan Publising’s emerging market blog:

Last Tuesday, I told Taipan Publishing Group subscribers in Taipan Insider that one Middle Eastern country was injecting massive amounts of cash into international markets.

That’s not really news nowadays, though, is it? Everyone’s heard of the $7.5 billion Citigroup (NYSE:C) bailout by Abu Dhabi back in November 2007.

But things have noticably been slowing down. When billions of dollars worth of investments get halved in value in less than a year, it makes you think.

Yet for some regions, this credit crunch is an opportunity of a lifetime.

Think about it. You’re an oil-rich nation with foreign currency reserves well into the hundreds of billions. Major global institutions are searching desparately for cash. Their fellow financial institutions are equally cash-strapped.

Suddenly, your country has a lot of power.

Now, who knows how long global financial systems are going to be in crisis… who knows how long major markets are going to wallow at lows not seen in decades. You need to act, and act now to secure your new position as a “Global Player.”

That’s just what some countries, like Abu Dhabi and Qatar, are doing.

Instead of accepting a government bailout, UK bank Barclays (NYSE:BCS) is selling stakes to sovereign wealth funds in Abu Dhabi and Qatar.

These stakes are worth about $12 billion and they will up Qatar’s BCS holdings to 12.7% and Abu Dhabi’s holdings to 16.3%. And while this injection might keep BCS independent from its own government, it sure gives these Middle Eastern countries a big boost in global power standings.

(By the way, another UK bank HSBC (NYSE:HBC) opted not to take UK cash for a bailout. It says it remains one of the most capitalized and liquid banks in the world. But if it does become cash-strapped, I’ve a feeling it’ll tap China’s sovereign wealth fund, CIC for funds.)

So what does a move like this mean for those oil sheikhs with wads of cash burning a whole in the country’s collective pocket?

It means diversification away from oil (and the dollar).  The BBC reported last Sunday, “Shares in the oil-rich Gulf region have fallen back as investors worried about the impact of the global economic downturn on the region.” Meaning falling oil consumption.

But it also means power.

TAQA is one of Abu Dhabi’s smaller sovereign wealth funds with about $28 billion in assets. Peter Barker-Homek is the chief executive. He told the BBC’s Christian Fraser, “Abu Dhabi’s sheikhs are looking beyond the simple financial return: they want to become true global players… Part of our role is really to close the divide between east and west. The end state will be a company that we hope will be one of the top 50 global employers.”

That’s partially why Barclays has chosen to align itself with governments outside the UK. CEO John Varley told Business Intelligence Middle East, “There has been a significant shift in the availability of capital and economic power in the world over the last five years and we’re ensuring we’re aligned with those changes.

That includes, of course, the Middle East, whose sovereign wealth funds will own about 32% of Barclays once this funding deal goes through. (China and Singapore have stakes in the UK bank, as well.)

This could be the year of “Follow the Money” as sovereign wealth funds begin to snap up deals all over the world.

The price certainly looks right…

Source: Middle East Money Funds Busted Barclays

Now with oil down more than 50% from near $150 a barrel in July, the Persian Gulf is beginning to suffer from its own credit squeeze.

The bottom line is that world credit markets could suffer, further crippling the economy and the banking industry.

Persian Gulf SWFs control huge amounts of money. The combined funds of the United Arab Emirates (UAE), Saudi Arabia, Kuwait, and Qatar account for more than half the $2.5 trillion total assets of global SWFs.

As of March 2007, the UAE and Saudi Arabia had, respectively, the first and third largest SWFs internationally, and Kuwait ranked sixth, according to Middle East Quarterly. Persian Gulf SWFs have become the favored investment vehicles of Kuwait, Qatar, and the United Arab Emirates. And they’ve been busy…

Last year, SWFs engaged in 173 corporate transactions representing $83 billion – twice that of 2006, according to mergers and acquisitions tracker Zepher.

But now, many Persian Gulf nations are staring at barrels of oil that could sell for $65 each versus near-$150 over the summer.

The Persian Gulf also had a rude awakening that despite its oil riches, it is not completely decoupled from the world’s stock markets. Across the Persian Gulf, stock markets are way down, as investors begin to panic.

Even the boomtown of Dubai, which may have the most high-profile real-estate market anywhere, has softened against tightened credit.

But a slowdown in the Persian Gulf might feel like a crash landing in places like Egypt, Jordan and Syria, where gulf money has helped prop up strained economies.

“I expect investments from the gulf to slow down or stop because they have to deal with their own problems before they invest in other countries,” Nabil Samman, an economist who runs the Damascus-based Center for Research and Documentation, told the New York Times recently.

But is it a slowdown or a crash?

The governments of Kuwait and Saudi Arabia are now in the throes of their national bank bailouts to the tune of tens of billions of dollars. And it’s not due to just low oil prices, but a mass exodus of foreign capital and unfavorable currency trades.

At this rate it’s bound to get worse as we approach 2009. Some experts are predicting oil prices of $50-$60 per barrel for next year.

If that turns out to be the case, world credit markets could wish oil were once again up to $150.00.

Addressing the European Parliament, President Sarkozy implored his European contemporaries to embrace the current period of economic upheaval as an opportunity to restructure the global financial system. According to the Daily Telegraph, he also articulated the concern of many Western authorities that sovereign wealth funds, located primarily in Asia and the Middle East, could use their massive cash reserves to scoop up key foreign assets at extraordinarily low valuations.

“Stock markets are at historic lows. I do not want European citizens to wake up a few months from now and discover that European companies belong to non-European capital which has bought at the lowest point of the stock exchange,” Sarkozy said. “I would ask that all of us consider how interesting it would be to set up sovereign funds in each of our countries – and maybe these national sovereign funds could now and again coordinate to give an industrial response to the crisis.”

Sovereign wealth funds, or SWFs, currently control an estimated $3 trillion. That’s already believed to be more than the $1.5 trillion to $2 trillion held by worldwide hedge funds (though some sources put the hedge-fund estimate as high as $5 trillion).

The International Monetary Fund (IMF) and other experts predict the state-run venture funds could control $12 trillion by 2015. But Money Morning Investment Director Keith Fitz-Gerald thinks the ultimate total will actually be much higher: Even now, he estimates that the total capital under the control of the “Global Cash Barons” is more likely to reach $20 trillion by the middle of the next decade. [To fully understand the growing power and influence of sovereign wealth funds worldwide, check out this Money Morning report: “Three Ways to Profit From Sovereign Wealth Funds: The Next Wall Street.”]

Some of the most prominent funds include China Investment Corp., which holds an estimated $200 billion, and the Abu Dhabi Investment Authority, which controls as much as $875 billion.

Conflicts of interests have already cropped up with respect to international takeovers, most notably in the form of Bain Capital Partners LLC and Huawei Technologies Co.’s failed takeover of Marlborough, Mass.-based 3Com Corp. (COMS).

In September 2007, China’s No. 1 network-equipment maker and Bain Capital launched a $2.2 billion takeover bid for 3Com. The deal stipulated that Huawei would receive a 16% stake in 3Com, leaving the rest to Bain. However, complications arose when the U.S. government expressed reservation about the deal and the possible breach of national security.

The fact that Shenzhen-based Huawei was founded by Ren Zhengfei, a former officer in the Chinese army, raised suspicion about the company’s intentions for 3Com, which has its own ties to the Pentagon.

3Com’s Tipping Point unit makes security software for the U.S. government, and policymakers worry that 3Com’s networking technology would allow China to eavesdrop on U.S. domestic conversations. Another concern was that the company’s encryption technology would make Chinese networks harder to tap.

Similarly, the year prior, Dubai Ports World – a United Arab Emirates-based maritime company – bowed to pressure from U.S. Congress and sold off its U.S. port operations to an American owner.

“There are a number of big French or European groups whose market value today is a third of what it was six months ago,” Sarkozy said, expressing his reservations about the growing role of SWFs. “Yet, there exists in the world sovereign funds with considerable means,” he said.

Europe’s Dow Jones Stoxx 600 Index has lost nearly half of its value since peaking in June 2007.

Sarkozy deflected criticism from former European Trade Commissioner Peter Mandelson, who described attempts to exclude foreign competitors from European markets as a modern day, economic “Maginot Line,” the highly touted, very expensive, and supremely ineffective defensive barrier erected in France prior to World War II as a deterrent to German intrusion.

“It is not a question of building a Maginot Line,” said Sarkozy, “What you have to do is take into account the pragmatic situation, the markets are depressed.”

Critics of Sarkozy’s request point out that Europe lacks adequate funding to create its own SWFs. The funds that sprang from Asia and the Middle East in recent years have huge pools of foreign exchange reserves and petrodollars to draw from. European nations don’t have these stockpiles of cash.

“We simply don’t have the money,” Joerg Kraemer, chief economist at Frankfurt-based Commerzbank AG (OTC ADR: CRZBY) told Bloomberg.

Sarkozy’s proposal also “suggests that all foreign sovereign wealth funds are negative,” Kramer went on. “That’s an assumption I don’t share.”

Source: French President Sarkozy Calls for European Sovereign Wealth Funds to Protect Assets

For sovereign wealth funds (SWFs), the answer is commercial real estate. These mega funds are homing in on the sector right now, according to emerging markets expert Irwin Greenstein.

We keep hearing about the real-estate meltdown. But as of the end of September, REITs have been up about 2% for the year — a far cry from the wreckage of other markets.

Whether or not the SWFs are quietly propping up commercial REITs may never really be known. But what we do for sure is that these state-owned mega-funds are honing in on commercial real estate.

If you haven’t heard of a SWF, it’s a state-owned investment fund — often with assets in the billions. Many originate in countries with huge surpluses either from trade or commodities, and they have to keep this money in play all the time.

According to a report from AltAssets, SWFs are moving away from mature industrialized markets and into the so-called MENA regions, an acronym for Middle East North Africa.

In fact, with 2008, SWFs have been focused more on MENA than in the previous year.

What does this have to do with commercial real estate?

For SWFs, emerging markets such as MENA and commercial real estate pose less of a risk than the U.S.

In the second quarter of 2008 the SWFs tracked in the study made 43 deals totaling $26.5 billion, compared to 42 deals and $58.3bn during the previous quarter. More than half the deals and funds invested were in emerging markets.

In conjunction with rising interest in emerging markets, SWFs are allocating an increasing amount of money to commercial real estate.

A report issued by the international capital group of Jones Lang LaSalle said that the second-largest sovereign wealth fund, Norway Government Pension Fund, recently allocated 5% of its assets to real estate, infusing another $20 billion of capital into the real estate markets.

The report continues…

“If China follows suit with 5% of their foreign allocation into real estate, we are at nearly $25 billion. If Korea puts a third of their $10 billion allocated to alternative investment in real estate, that brings the total of fresh real estate capital coming to play in the short term up to $28 billion.”

Another report from real estate services giant CB Richard Ellis says SWFs will potentially invest around $725 billion in the next seven years in the global commercial property markets.

The Ellis report says that typical safe havens will include central London, but other trophy real estate targets could be New York, where the Abu Dhabi Investment Council bought the Chrysler Building.

Distressed real estate is ideally suited to the long-term appreciation strategies of SWFs.

With nearly $4 trillion of total assets currently under SWF control, a 7% allocation would mean worldwide commercial real estate investments totaling $280 billion, according to Ellis.

Putting the figures in perspective, Ellis observed that entire U.S. institutional-grade property portfolio owned or managed by investment managers and plan sponsors is valued at approximately $330 billion.

Based on this research, if you’re a headline investor commercial REITs may not be too appealing at this point in time. For contrarian profit seekers, it could be a good move.

Last week, Russia and Venezuela finalized their deal to bolster cooperation in the oil and gas markets. Russia’s state gas monopoly OAO Gazprom and Venezuela’s Petroleos de Venezuela SA have inked a memorandum of understanding that allows for greater cooperation between the companies.

To help seal the deal, Russia is granting Venezuela a $1 billion credit for the purchase of Russian weaponry. After all, you never know if ExxonMobil (NYSE:XOM) and ConocoPhillips (NYSE:COP) will get the Bush administration to invade in an effort to take back their investments in Venezuela.

And it could get worse for American companies as they inadvertently build out energy infrastructures that are appropriated by emerging nations that have petro-fascists sitting on the throne.

A recent article in The Economist questioned whether high oil prices will stimulate “resource nationalism.” In addition to Venezuela’s seizure, Bolivia and Ecuador forced international companies to make similar concessions.

At about the same time, TNK-BP, a Russian subsidiary of BP, had to sell a major stake in its oil business to the national gas monopoly Gazprom. And in 2006, Royal Dutch Shell was forced to sell a 50%-plus-one-share stake in the Sakhalin-2 oil field to Gazprom.

A consortium including ExxonMobil, Total, Shell and ConocoPhillips has already invested $17 billion in developing the Kashagan Field in Kazakhstan. But over the past two years, Kazakhstan has escalated its demands, forcing these international oil companies to reduce their stake in order to give state-owned KMG a larger share.

This trend is bad news for US consumers. Since most of these regimes are openly anti-American, they could push up the price of gas at the pump.

And politics aside, the management of energy facilities by these state-owned agencies is downright inefficient compared with the more experienced Western companies – in turn achieving the same effect as political price gouging.

As The Economist explains, most national appropriations took place in the 1970s, when oil hit historically high levels. Once the oil price came down in the 1980s and 1990s, the move to nationalize “virtually disappeared and re-emerged only in the last decade when oil prices climbed back to 1970s’ levels.”

We can only expect this trend to continue unless there is a collapse of oil prices. In the mean time, we find that the US oil companies find themselves as accidental Communists.

The last two big investment banks, Goldman Sachs (NYSE:GS) and Morgan Stanley (NYSE:MS), have abandoned their freewheeling, frat-boy days to become bank holding companies. The move puts them under stricter Federal regulation. More important, they will now look to more conservative sources of money – such as customer deposits – over highly leveraged trading bets.

What remains to be seen, though, is whether the shift could dam up a torrent of money flowing into emerging markets.

Back in the day, emerging markets were the place for investment bankers to wheel and deal. Asia, the Middle East and Latin America became increasingly reliant on this Wall Street money.

Since 2005, both the share and percentage of emerging-market investment banking saw dramatic growth. In 2005, investment-banking revenue from emerging markets accounted for almost $40 billion, or 16% of the global investment-banking revenue total. Those figures increased to just over $78 billion, a 21% share of the total in 2007, according to the McKinsey Quarterly.

When the results of this study were published in August 2008, it forecast that emerging markets’ share of investment banking revenue would soar to 28%-30% by 2010. That translated into a cash infusion of somewhere between $40 and $115 billion by 2010.

Even if European investment banks became more aggressive in emerging markets, the cash shortfall would still be painful. We saw emerging markets tank with the credit crunch. Now the future has turned more uncertain.

It’s also conceivable that the filthy rich Sovereign Wealth Fund of the Middle East and Asia could plug the gap.

At this point in time, it would be best to take a wait-and-see approach to investing in any emerging market funds. If you feel compelled to take a position in an emerging market, you may be better off finding a great company with a lot of promise.

But, be warned. Lynn says these secretive funds could be hiding the next round of market ugliness…

Ever since Adam Smith wrote Wealth of Nations, we’ve known the first rule of unfettered economics — supply and demand balance each other. The second rule is that money moves on. There are numerous interesting examples of this at work right now.

Knowing where money is flowing might help you make some slightly different investment decisions. It also makes some mysteries clear.

Last Thursday, in IDE, for instance, I’d found an interesting study of dollar strength and stock market returns to share with you. That London Business School/ABN Amro study found that the stock markets of strong currency countries tended to do worse than the markets of countries with weak currencies.

It seems counterintuitive. Why would anyone want to invest in a hot market if every drachma, real, rupee, dinar, or whatever that you made would become less valuable the longer you owned them? The second rule explains why.

Money moves where it multiplies best. Judgment does not always go along. While certain investors are super-smart about where to go and what the full, long-term implications are, most money is simply hot money. It’s greedy, spontaneous and slightly irrational.

Need an example? I’ll bet you’ve got one right on the street where you live. Look at all the people around you who said “housing prices here are crazy, nobody could afford this on a normal salary” with one breath and “I bought a house with nothing down and I plan to resell it for a big profit,” with the next breath. Even as they knew the market had gone too far, they saw everyone else’s profits and couldn’t help themselves.

One of the effects of hot money has hit Hollywood. The Brazilian real is very strong right now. According to Bloomberg, the currency has gone up 83% against the dollar in four years. Given the study I showed you last week, you might think twice about investing in Brazil unless the prospect is very solid. But if you are a movie star…

Brazilian marketers are suddenly able to afford stars like Sarah Jessica Parker and Sylvester Stallone because they now come cheaper than their homegrown celebrities. The real is so strong against the dollar that the marketers can buy U.S. stars at lower prices than they have to pay their own.

Some think this is a sure sign that the real is not only overvalued, but ripe for a big fall.

But when you want to talk big hot, hot, hot money, look to the sovereign wealth funds. The International Monetary Fund (that’s the bank, not another wealth fund) believes that these country-owned investment funds control about $3 trillion at present and will rule over $12 trillion by 2012.

If they don’t do anything too stupid, is what I say. Professor Olivia Mitchell of Wharton says that many of these funds are developing big appetites for risk and have “virtually no clarity of objectives” or transparency. And ditto for many hedge funds.

A good example of how this hot money takes big risks is Abu Dhabi’s $7.5 billion investment in Citigroup this year, which has netted a 40% loss so far.

Most of these funds are secretive, so we have no idea how many put big bets down on mortgage-backed securities. In fact, I wouldn’t be surprised if much of the future ugliness that many expect to see among irresponsible banks will actually be elsewhere—in sovereign wealth funds.

Source: How Hollywood, Hedge Funds and Billionaires Can Show You Where to Invest