Since returning to work in 2021, Vern and I have been sparring over the usefulness of cash in an investor’s portfolio. He thinks it’s undervalued, I think it’s getting devalued and therefore shouldn’t be a major part of your portfolio.
As you know from reading Vern’s work, he thinks stock markets are hugely overvalued and that a decline of 50% in value is a possibility.
Yes, it is a possibility. That I acknowledge. But I would say there is a much larger possibility that cash will lose 50% of its purchasing power over the next five to 10 years against a well selected portfolio of assets.
That’s the thing about financial markets. There are no certainties. You simply don’t know how the future is going to play out. So you have to diversify. Gold, cash and bonds for the slowdown and defensive positioning. Shares for growth.
Rather than sit in cash and wait, in my view you should only use it for tactical purposes. Build up your cash balance to 10%…or even 20% when markets are extremely frothy and deploy it during the corrections.
The hard part is knowing where we are in terms of the frothiness.
I’m seeing A LOT of froth in the smaller end of the market. Anything speculative, with little to no revenues and earnings, allows investors to go to town with their imaginations when it comes to valuations.
For example, each day, I scan the ASX for companies making two-month highs. This morning, 184 securities popped up on my list. Very few of those were in the ASX 200. The vast majority are in the small to microcap space. Most probably don’t have earnings yet.
So if you’re playing at this end of the market, you’d want to be taking some money off the table and building up a bit of cash. The speculative end of the market has had a VERY good run since last year. We know these moves run out of energy at some point. It’s just a question of when.
The bigger stocks, on the other hand, aren’t moving in unison. The big banks and resources are dragging the ASX 200 higher, but underneath those large caps, there is a bit of weakness around. In other words, there isn’t a lot of froth at this end of the market.
You can see the relative difference in the chart below. It shows the ASX 200 relative to the Small Ordinaries Index. As you can see, the ASX 200 is the cheapest it’s been in some time against the small-caps.
How long will it be before capital shifts away from the smaller players and into the bigger stocks?
But getting back to cash…
I advocate holding it for tactical purposes only. It provides optionality in that you can take advantage of mispricings but it doesn’t provide safety. Rather, it only gives the illusion of being safe.
The lack of volatility that cash brings to the portfolio hides the fact that policy makers are destroying its purchasing power.
In the next few years, QE will seem like conventional monetary policy. Governments around the world will be employing Modern Monetary Theory (MMT), and central banks will be rolling out central bank digital currencies. This is all designed to have greater control over how you receive and spend your money.
The idea of intangible assets is a dangerous one
MMT is basically where the Treasury does away with primary dealer banks marketing their bonds and raising cash via financial markets. Under MMT, the Treasury just goes straight to the central bank. It’s direct financing of government spending.
The theorists who came up with the idea reckon unelected bureaucrats will be smart enough to use taxes and tax rates to prevent inflation and direct the spending where it ‘needs’ to go.
Do you think cash is going to hold its value in such a scenario?
Let me put it another way. A 50% fall in the market means a 50% increase in the purchasing power of cash against real assets like stocks. As I said, such a fall is not impossible. But what do you think these clowns will do when that happens? And will you be smart enough and brave enough to deploy all your cash after such a massive fall.
People will be too busy patting you on the back for being so smart and staying in cash all these years, that you won’t have the mental flexibility to adjust your views. I can almost guarantee it!
The decision to be in cash or stocks is not a binary one. You can invest sensibly and minimise risk as much as possible. Hold tactical cash. Own gold and gold stocks. Focus on quality companies with decent returns on equity that aren’t overly expensive. Look at sectors where the hot money isn’t in, you can often find bargains there.
In short, you can be an investor, not a punter. Invest in businesses, and over time you should do well.
One final point of Vern’s that I agree on: The idea of intangible assets is a dangerous one. These businesses are highly profitable, but the lack of tangible assets allows investors (who turn into punters) to let their imaginations run wild. That’s how stocks become crazy overvalued.
More on that tomorrow…
Editor, The Rum Rebellion