Why cash could soon be king again
Stock markets have been recovering from their March sell-off.
In London the FTSE 100 has risen as high as 7,425 again. It was below 6,900 in the final week of March. And America’s S&P 500 – the biggest daddy index of them all – is also higher than its end-March lows. Meanwhile the VIX, the so called ‘fear’ equity gauge that measures investors’ blood pressure, has been in a downtrend once more.
Hurrah! Does that mean everything is all right with shares again?
Not so fast. This may be the last time to cash in your chips before the real sell-off.
And that would make cash into the real king once more…
Many market players get very excited about specific index levels.
For example, when the FTSE 100 breached the 7,500 level in May 2018, it was a source of much rejoicing by traders and media commentators.
Passing such milestones can also turn people more bullish. When the ‘Footsie’ reached (almost) 7,800 in mid-January this year, there were some optimists who reckoned the index was soon heading for 8,000.
In fact, that was the peak. But so what if the UK benchmark did climb another 3%?
In itself, in my view, the absolute level of the index doesn’t mean anything.
The only important consideration for me is how it compares with fundamental factors such as future interest rate trends or Britain’s corporate profit forecasts.
And on both counts, I see no reason to change my earlier view. Which is that, despite being below their highs, the UK’s stock market indices are still oscillating in very dangerous territory. They’re looking very vulnerable to another sharp sell-off.
In short, the upside potential is limited and the downside scope is large, as I’ve said several times in the pages of the Daily Reckoning.
To quote my US colleague Brian Maher, talking about American shares: “the stock market has begun to exhibit the classic symptoms of what professionals call manic depression. Its emotional swings are many… extreme… [and] just not right between the ears”.
But I’m not to going rant about this topic any more now. Today I want to talk about what’s still the ultimate way of protecting your portfolio from a potentially big fall.
It’s called cash.
When share prices rise to very high levels, here’s why I believe that raising more cash makes a lot of sense…
1) If you’re a genuine lifetime investor, you don’t need to worry about cash. You buy…and hold…and keep on holding forever. But that’s not how most market player operate. While I strongly endorse long-run thinking, sometimes optimism levels become overwhelming. That’s normally a bad sign and often signals that it’s right to take profits. Bank them and use the cash when prices have dropped back.
2) Most shares move with the headline equity indices. Granted, some stocks just keep on going up, meaning that you can continue to hold them through thick and thin (though you’ll only know later whether you’ve done the right thing or not).
But if an index such as the FSE 100 drops from an over-extended level, much of your portfolio will follow it down. So if you believe that some of your holdings are starting to look a bit pricey and that the overall market may be vulnerable to a sharp sell-off, it’s better to play safe. Take your profits while you can and use the money better later. In other words: ‘buy low and sell high’.
3) Remember the simple market math. If you decide to keep one of your favourite stocks which subsequently halves, the price then needs to double to get back to where it was. Even if you miss the peak, though, selling before a big drop could look very smart later on. As legendary investor Bernard Baruch said: “I made my money by selling too soon. I never lost money by turning a profit”.
4) Nowadays, it’s possible to hedge your position by shorting, in effect selling shares you don’t own in the hope of buying them back lower down. But shorting has downside risks as well. If you sell out to raise cash, you may get the timing wrong. But you’ll have no further liabilities to anyone. Your cash protects your capital.
5) When the index drops, it will create many investment opportunities. Imagine your frustration, though, if you can’t take advantage of these because you don’t have any financial ammo. Simply put, you can’t ‘buy low’ if you’re out of cash. It’s far better to take some profits when prices are high in order to build a ‘war chest’.
For Strategic Intelligence, both Jim Rickards and I have been suggesting to subscribers that they maintain around 25% of their portfolios in cash.
Sure, that’s way above the norm and can only be justified in exceptional circumstances. And in the long term, cash itself may be gradually ‘phased out’ and replaced by digital means.
But these are unusual times. Many stock look seriously over-valued. And even if we’re wrong and the mainstream indices don’t crumple, how much realistic upside can there be? I’d say there’s unlikely to be enough to justify holding expensive shares when cash looks a more appealing alternative.
In short, cash could soon be king once again.
Over the next few days, we’ll be in touch with a specific opportunity for you to make a potential profit from one major currency.
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