The ratio of mutual funds’ cash to their assets tends to be low at market peaks and high at market troughs. One explanation is that mutual funds have been consistently wrong at market extremes. Another is that variations in mutual fund liquid asset balances cause stock price levels to change; for example, the funds’ low cash position at market peaks keeps stocks from rising further, since there is so little buying power left. Either explanation implies that changes in institutional “buying power” signal changes in the market level.

Unfortunately, both explanations run counter to efficient market theory. The first ignores the fact that it is as difficult to be consistently wrong at market turning point as it is to be consistently right. And the second rests on the tacit assumption that the funds initiate the trading decision while the investors they trade with play a passive role. Without information about both buyers’ and sellers’ preferences, no analysis of a transaction can indicate the direction in which price will change, if indeed it changes it all. In fact, evidence shows no association between pension fund stock purchases and stock price changes.

There is a third and more reasonable explanation for the negative relation between the level of the stock market and funds’ cash-asset ratios: Changes in the denominator of the ratio—total assets—are caused by changes in the level of the stock market. The market value of the stocks institutional investors own rises and falls with the market.