Stocks need cash inflows to go higher, Cramer said Tuesday, but not all money is created equal. In fact, the wrong money source can kick a rally into reverse.
The best sources are retail investors returning to the market after a major sell-off, Cramer said, but buy-happy hedge funds and mutual funds are good, too. The constant flow of cash makes it easy to find investable sectors that can generate higher and higher returns. And when the flow is happening in conjunction with a turn in business, you should buy on any pullback.
But there’s another way that money can transfer into a rally’s leading stocks. Even if there’s no cash flowing in – or worse, it’s flowing out – investors can swap out of less exciting names and pour that money into the hot stocks of the moment. Often times it’s the food and drug companies that are left behind for some flashy tech or financial name.
The problem, though, is that this becomes a zero-sum game, meaning the rally’s fuel eventually will run out. As soon as the selling in the food and drug stocks is done, the leaders lose their momentum because there’s nothing left to drive them higher. And if the retail investors haven’t yet left the sidelines and returned to the market, then you can get a rally in the wrong stocks, reversing the previous one.
Then the food and drug names that were used as fuel can become the market’s new leaders. The cash that was pulled out is dumped back in because institutional investors think another downturn is coming. If it weren’t, they’d say, the food and drug stocks would still be headed lower. (Never mind that the group might be getting so cheap that they represent great value, Cramer said.)
Keep this in mind the next time you see a rally in Coca-Cola , Pepsico , Kellogg , Heinz and the rest of their cohort. Cramer called it “one of the most horrifying things” that can happen to the market because it means investors think the economy will continue to struggle or get worse.
Here’s the bottom line: Be cautious when you see the food and drugs rallying. At least until there is a significant amount of money coming in from the sidelines.
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