Look where the money is going

One way to determine the possible direction of stock markets is to look at where money is flowing to.

Smartmoney.com recently quoted the following from Henry "Chip" Dickson, chief US strategist for Lehman Brothers: "The equity market performs best alongside a widening [steepening] yield curve, narrowing credit spreads, and when the yield curve is already positively sloped."

It is true that a positively-sloped and steepening yield curve tends to be good for the equity market. Unfortunately a steep curve is often followed by a flattening of the curve. Indeed, that is what happened in 2004.

Having said that, a mere flattening of the yield curve is not necessarily fatal to the stock market. The worst markets have tended to be those preceded by a flat or inverted (negatively-sloped) yield curve.

Incidentally, Smartmoney.com also quoted Dickson as saying that the redeployment of corporate cash could help boost equities in 2005. However, Paul Kasriel, director of economic research for The Northern Trust Company, wrote recently: "[C]orporations are not spending all of their after-tax after-dividend cash flow on capital equipment and inventories... What makes it especially unusual is that the cost of capital -- be it equity or debt capital -- is so low now. This suggests that the expected return on capital in the U.S. might be unusually low now."

In other words, the availability of so much corporate cash is not necessarily a good sign.