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The Potential Value Of Cash

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    June 16, 2014

    In the popular press and TV financial shows, cash is a dirty word.

    After all, as they say, “It doesn’t earn interest or pay a dividend. It doesn’t grow in value. In fact, it just sits there, its value eroding at whatever is the pace of inflation”. “You can never get rich holding cash. It has to be working for you in investments.”

    However, I submit that you can only get rich by periodically holding high levels of cash.

    I was reminded of that by that report from London this week about how the world’s wealthiest people are currently holding big stockpiles of cash, more concerned right now about the high risk of losing wealth than the potential of adding to their wealth.

    The Reuters report said that the world’s wealthiest investors have raised cash levels to more than double what they held near the top in 2006 and 2007, prior to the 2008 meltdown. The report notes that a survey of 4,000 “rich investors” by Legg Mason shows they are holding an average of 26.5% in cash. An estimate by Wells Fargo Asset Management puts cash among its wealthiest clients at 40%.

    Those are huge numbers given that the very wealthy do not have it as easy as ordinary investors to sell a significant percentage of their holdings to move to cash. (Yet, we always learn after market plunges that even those with huge mega-holdings, like Warren Buffett, billionaire hedge fund managers, and other members of the “top 5%”, somehow quietly raised many $billions in cash prior to market tops, and put it back to work at the lows, scooping up beaten down stocks and indexes at their lows).

    So, what is the value of cash?

    At such times. it not only avoids the large losses in serious corrections and bear markets, and provides fuel for downside positions to make profits in those corrections, and also sits ready to take advantage of the low prices after market declines.

    And by avoiding the large losses, investors have the confidence and courage to get back in to take advantage of those low prices.

    Meanwhile, those who shrug off risk when it reaches historically dangerous levels, or are paying so little attention that they are unaware that risk is high, usually see that approach end very badly, with large unnecessary losses they may take a long time to recover from, in fact that some may never recover from.

    A reminder of how much it takes to recover if one allows investments to experience double-digit losses:

    Decline Needed to recover
    -10% +11%
    -20% +25%
    -30% +42%
    -40% +67%
    -50% +100%
    -60% +150%


    The S&P 500 lost 50% in each of the last two bear markets. The Nasdaq lost 78% in the 2000-2002 bear. It took 11 years, until 2013 for the S&P 500 just to recover to its level of 2000. The Nasdaq still has not.

    Don’t be fooled by last year’s unusually large 30% gain. Over the last 30 years, the S&P 500 has averaged an annual gain of 11.1%. Over the last 15 years just 5.5%.

    The wealth inequality between the middle class and the “top 5%”, which is causing so much concern the last couple of years, will only continue to increase as long as the wealthy raise cash when risk rises, and buy back in at the lows, while most investors have losses and spend years just hoping to get back to even.

    Is this such a time?

    Markets remain within 1 or 2% of record highs.

    It was interesting that once again the market followed its pattern of the monthly jobs report usually creating a one to three day triple-digit move by the Dow in one direction or the other, which is then usually reversed in subsequent days.

    The Dow was up 108 points over the three days beginning Friday when the jobs report came out, and then back down Wednesday and Thursday this week. But the down was greater than the up this time, with the Dow down 211 points in the two days.

    We suspect there is more downside to come next week, since the short-term overbought condition was hardly affected.



    Do markets need a catalyst to top them out?

    With investor sentiment at very high bullish levels, I’ve been seeing a number of comments by investors in the visitors’ comment sections of websites, explaining why they are not worried.

    Some relate to generalizations, “The U.S. economy is the strongest on earth and always will be”. “Cars sales are going gangbusters, jobs are growing, the economic recovery is picking up steam”. “The smart money was dumb last year to be worried, and still is this year.”

    But another explanation that pops up with some frequency boils down to some version of “There is always a catalyst that causes markets to top out, and I don’t see any on the horizon.” Examples they provide include the Asian currency crisis in 1998 prior to the 1998 mini-crash, the dotcom bubble bursting in 1999, the real estate bubble bursting in 2006.

    However, a closer look at previous tops reveals that almost always what was later identified as the catalyst wasn’t seen as such at the time. It was usually that after market collapses, analysts looked back at conditions and picked out what seemed to be the catalyst.

    For instance, looking back, analysts could see that when the housing bubble burst that led to the collapse of sub-prime mortgages, which led to the collapse of over-leveraged banks, which ultimately resulted in the collapse of the entire financial system. So the bursting of the housing bubble was obviously the catalyst for the stock market collapse.

    But at the time, those situations were not seen as catalysts for anything until it was way too late. Wall Street, the Federal Reserve, and realtor associations denied there was even a bubble in housing prices, and when prices began to fall provided assurances that it would be just a brief pullback to consolidate gains before the next leg up. When prices continued to fall, they provided believable reasons why the problem would be confined to housing. When it spread to sub-prime mortgages and lenders, they assured that the problem was an isolated situation that would not affect the otherwise strong economy or markets.

    And indeed, even though the housing bubble burst in 2006 (and as we learned later, homebuilder insiders had sold their stocks heavily before they collapsed), the overall stock market continued to climb higher until late 2007. None of what later were seen as the catalysts were seen as such at the time.

    It was similar at other tops. The subsequent catalysts were not identified until afterward.

    If the market had topped out any time in the last 12 months, analysts would have looked back and easily seen any number of situations they could identify after the fact as the catalyst. From within the U.S.: The Fed’s warning last year that it might begin tapering back QE; the  actual decision to begin tapering; the uncertainty of a new chairman running the Fed; the economic slowdown, the surprise of 1st quarter GDP growth plunging to negative 1%, and so on. From outside the U.S.: the periodic negative news on China’s economy, or India’s, the military coup in Egypt, or outbreak of civil war in Syria or the Ukraine, or now in Iraq.   

    So, don’t put a lot of faith in the expectation that there will be a sign, a catalyst that will indicate when the top is in. There will be an apparent catalyst. But it will be chosen from events and situations that are constantly popping up, always present, and will not be identified until afterward.

    The fact is that most tops have simply taken place when the market has become over-valued, the number of investors taking profits increased, key support levels were broken triggering more stop loss points, and the decline was on. 

    It usually only shows up in charts and technical indicators.




    To read my weekend newspaper column click here:  Worry about the Second Quarter, Q1 is History



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    About The Author – Sy Harding, Street Smart Report

    Sy Harding publishes the financial website Street Smart Report Online and a free daily Internet blog at Sy’s Free Blog. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beat the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!

    It includes our research and analysis on the economy and markets, and provides charts and buy and sell signals on the major market indexes, sectors, bonds, gold, individual stocks and etf’s, including short-sales and ‘inverse’ etf’s.

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