Investing in the markets can turn a rational person into an irrational one. The tug of war between fear and greed is ever present. On the greed side of the equation, the investment community has coined the term FOMO (Fear of Missing Out) – fear of missing out on a bull market run; during a bear market, there is a different kind of fear – fear of wealth destruction.Conventional wisdom among most traditional investors is that one should be fully invested at all times. Many simply cannot justify keeping their money in cash earning less than 0.02%. From their perspective, they are forgoing the long-term growth opportunities associated with investing in equities. And they are losing purchasing power, given the yield on cash is a paltry 0.02% - not enough to keep up with the current rate of inflation.
We, on the other hand, believe that using your hard-earned money to purchase a stock should be no different from considering when to buy just about anything. A sensible consumer does not run out and spend all of their money to buy a television or a house when they are at their most expensive.
We suggest a similar approach when considering stocks – instead of buying at peak prices, we believe it’s worth considering waiting until stocks “go on sale” before making your purchase. In the meantime, you hold cash or cash equivalents so you can have some “dry powder” ready when stocks go on sale.
An Aging, Expensive Bull Market
So this begs the question – is the market “old” and is it “expensive”?
From an “age” perspective, this is a fairly “old bull”, currently running just over seven years. But bull markets don’t typically die of old age.
However, stocks are expensive from an historical perspective, currently trading roughly at valuations seen only four times over the last 115 years – in 1901, 1929, 1966 and 2000. And over the weekend, Goldman Sachs joined this discussion, stating that the typical stock in the S&P 500 trades at 18.1 times forward earnings, which ranks in the 98th percentile of historical valuation since 1976.
Market tops can be frustrating – drawn out, with price spikes, and increased volatility. And seldom do bull markets end without other important warning flags. For example, deterioration in breadth is one area that money managers focus on–that is, is there an increasing number of stocks moving down compared to those moving up? Right now, market breadth remains constructive. However, with market valuations stretched, just like a hot air balloon that is over-inflated, it may not take much to tip the balance.
We have no preconceived notion of when this bull market will end or what the trigger will be. It could be any number of factors. One possible culprit is the Federal Reserve’s interest rate policy. Chairwoman Yellen continues to intimate that rates will rise this summer, or in the fall. From an historical perspective, the first one, two or three interest rate hikes have seldom killed a bull market. But, like all debates related to the market, opinions vary. Some think that this tightening cycle will be different in a very negative way, given the Fed’s big balance sheet, no past experience with increases starting from near zero interest rates, and a Fed that is dangerously late in changing policy. Others agree that it will be different, but in the opposite way – that the tightening cycle will be gentle and prolonged. My guess is that this debate will continue for months, if not years.
Right Now, Cash Is King in Our World
During the past few months, we have maintained a cash/defensive position between 10 - 20% in our moderately aggressive equity ETF (exchange traded fund) portfolios. This is primarily driven by current market valuations – and the fact that we want to have some cash on the sidelines to buy, as and when the market gets cheaper. However, we have increased our cash position in our two stock portfolios – partially due to taking profits on existing positions, but also due to the fact we can’t find any good deals out there!
By our own standards, our current allocations to cash/short-term instruments do not represent our target for bear market, defensive allocation. Rather, we view our current holdings as a waypoint for our safety-first strategy. We believe our clients primarily pay us to manage risk – to strive to mitigate the wealth destruction that occurs during bear markets.
Perhaps, you’re opposed to holding cash for the reasons stated in the beginning of this blog. If, however, you are holding cash, suddenly the purchasing power of your cash will be increased dramatically, as and when the next bear market arises.
In closing, given current market valuations, we are inclined towards “cash is king” - not trash. Feel free to join the conversation!
Alexis Advisors, LLC is Registered Investment Advisor with the Commonwealth of Virginia. Information contained herein is for informational purposes only and is subject to various interpretations and timeframes, and should not be considered investment advice. Please contact Advisor promptly if there are any changes in your financial situation or investment objectives, or if you wish to impose, add or modify any reasonable restrictions to the management of your account. Since the confidentiality of internet email cannot be guaranteed, do no include private or confidential information such as passwords, account numbers, or social security numbers. Additionally, instructions having financial consequences such as trade orders, fund transfers, etc. should not be included in your email communications, as we cannot act on unconfirmed instructions received via email. Nothing in this transmission should be construed as an offer or solicitation to purchase or sell securities. Investments in securities and insurance products are not FDIC insured, not bank guaranteed, and may lose value. Advisor’s current Disclosure Brochure is set forth on Form ADV Part 2 and is available for your review upon request.