100% Cash, Ready for the Crash

[yader]

Clickbait title.

 

I'm now at 100% cash (this is true).  Sold all positions today because of the charts below.  We may be starting a new bull market and I might be missing out on some gains because of it.  We could also be in a stage of bullish "capitulation" and see another large crash in equities.  I'm ready for the latter.  The trade off is missing 15% gains in the next year or making multiples upon multiples.

 

The past down cycle (housing bust) I was near fully invested.  Had I not been, and recognized it for what it was, I'd be retired right now.  Wasn't in the game for the DotCom crash.

 

Would love some feedback.

[cmlber]

Why are you assuming downside to being 100% in cash is just missing 15% over the next year? 

 

Would you throw in the towel on your 100% cash bet in exactly 1 year if the market goes up 15%? 

 

I would think you would get more conviction in being all cash and then risk another 6-8%. 

 

And then you'd get more conviction and risk another 6-8%, and another 6-8%, and another 6-8%. 

 

Isn't the risk much greater than what happens over the next year?  The real risk is that this is a 10+ year bull market and you never get back in because you'll always have a tough time psychologically jumping back into the market after it's up a lot.

 

I'm not saying we're in for a 10 year bull market (I have no idea one way or the other), but it's also not impossible to imagine that scenario.  100% cash seems risky to me.  I'd rather just pick good businesses priced right and not worry about where the markets are priced as a whole. 

 

 

[enoch01]

 

Would love some feedback.

 

Unless you are a successful macro trader I think this is not the right way to look at things.  If you can find cheap stuff, buy it.  If you can't, sit in cash.

[KCLarkin]

Yader, I don't think being 100% cash is necessarily wrong. But doing it because of market timing is likely very dumb.

 

For example, based on your charts, the "market" was expensive in February 2016. But you could have bought BAC at $11.xx. Based on your logic, you wouldn't have bought BAC because a "crash" might be coming.

 

Maybe financials aren't your cup of tea, but there were hundreds of companies that were objectively cheap at various points in the past year. Isn't your time better spent on finding these? If Keynes, one of the smartest men of the past century couldn't time markets, why do you think you have an advantage?

[AzCactus]

Generally, being 100% in anything seems a bit arrogant.  But being 100% invested in cash seems  a lot like predicting the market.  If you find a cheap stock buy it...if you don't cash makes sense. 

[yader]

Thanks all for the feedback.

 

Yes, it could feel like market timing.  I would say however that this isn't market timing in the sense of a 1 month swing trade.  This is more of a macro judgment that I'm willing to let play for 1 year.  Call it a 1-yr option.  My loss or option is the 10-15% (plus compounding) if wrong.  We make this kind of judgment all the time with undervalued stocks.  We don't need to know when the value will be realized but we need to have some reasonable probability it will within a given time frame.  I take a 2-4 year time horizon to realize value (personal investment style).  In going 100% cash I'm saying that if right my catalysts will happen in the next year.

 

To me this feels like a 1-yr risk/reward bet.  Yes I'll sacrifice some compounding, but I've not lost any actual capital.  A real threat is never getting back in and missing a 10-yr bull market.  I won't mind eating humble pie in a year and getting back in where there is value.

 

Pragmatically, if a screaming deal comes along in the next year I'll put 5-10% on it.

[AzCactus]

I would be curious to know what stocks you recently sold and if that had more to do with their value or your opinion of the market in general.

[wachtwoord]

If you feel strongly about this I would advise you to keep invested in the companies you like and to purchase puts along side them.

 

I don't believe I can time the market so I'm always fully invested. Holding cash is like holding a meting snow-ball, losing purchasing value every year.

[yader]

AzCactus - here's the spread.  I was in SSW and got hammered, -50%.  I was also in SRT, 100+%.  Had an 80% rate of positive picks, 15% net gain last year.  Other names were ALS, LMCA, LBRDA, BATRA, PDER, BFCF, HLC, OTEX, LSXMA, WPT, FIT (ugh), HHC.

[Uccmal]

Interesting way to handle things.  I have never been anything but fully invested for 20+ years. 

 

But I have to say that things are getting lofty now.  It feels alot like 2007, summer and fall, just before the Bears Stearns mortgage funds blew up.  Markets were overvalued then but not terribly overvalued.  Markets today are aguably way more overvalued on nearly every metric than they were in 2007.  PE; PB; Market cap to GDP.  People will justify this by saying that the discount rate is low, but its appearing to be more volatile lately. 

 

In 2007, the housing bubble had been going full force for years.  There was a vague sense that it was not going to end well.  Today, everyone has run debt up to huge levels.  The US at all levels of government is in excess of 30 Trillion.  At the federal level the debt has gone from 10 to 20 T in 8 years:  thats 7% per year increase against < 2% inflation.  And that is just the US.  Excepting a few countries here and there debt levels have been skyrocketing.  And interest levels cant be lowered to service the debt.  If interest rates do in fact rise, somehow against the backdrop of all this debt, then debt payments are going to rise.  That I believe is the achilles heel. 

 

In summer 2008 the runaway mortgage crisis was 'contained' and there wasn't going to be any contagion.  Government is going to tell you that debt levels are manageable, and maybe they are, until they aren't.  And against this backdrop the worlds biggest economy just elected a tax and spend liberal/conservative? who wants to run up more debt.  And the US isn't alone with huge debts.  My province has record debt... CDN households have record debt.  You cant buy a car, a house, or anything else, when you can no longer service existing debts due to interest rate increases. 

 

And then there is simply the long duration without a bear market, and recession. With each passing month we get closer and closer.  And the longer we forestall it, the worse it wil be.  This time there wont be any V shaped capitulation driven by quantitative easing because government is out of money.  The 'backtracker' will be deep into government spending just to stand still. 

 

Lets just say I have become much more cautious these last few months and have been deleveraging and hedging.  I walked into the 2008, and 2009 redux, unaware of how fast, and how badly things can unravel.  Add to all this: there is no real good value to be had anywhere right now.  That should be signal enough for us. 

 

 

 

 

[rb]

Yea, I don't have a big urge to sell anything that I have. I'm sort of ok with where they are. But also I'm having a very hard time finding new stuff to buy.

 

I don't think we're on the verge of a crisis. But why is anyone looking for a crisis to spark a selloff? If I recall things were ok in 1987 and 2002. That didn't prevent the stock market from giving a beat down to investors. I'd add that in my view the market optimism is somewhat superficial. It didn't take a lot for stocks to sell off quite a bit last fall and early this year. So I think that we might just have an old fashion boring pullback just because the markets ran a little too far and a little too fast.

 

To paraphrase Uccmal, when there's no real good value to be had anywhere anymore, it's probably a good indication that we're due for a pullback. Where it comes from? Who knows?

[dwy000]

Just curious - if you're investing for a crash (or I guess uninvesting), what happens if there is no crash?  If the market is flat or is up/down say 3% next year will you pile back in?  I thought it was fairly priced before the election and am very glad I didn't sell out.  Too many times I've watched an overpriced market rise up even further.

 

I prefer to pick stocks I think will outperform the market over the long term and let the market do whatever it will do.

[UNF2007]

I kind of feel the same way for a few reasons. 1. if interest rates are like gravity when valuing equity, what happens when they start cranking the dial the other way? 2. I can't find any compelling values at the moment 3. The market seems to be pricing in lots of stuff that hasn't happened yet based on the election 4. the opinion of the financial pundits seems to have gone from cautious optimism to complete risk off with rose colored glasses which can influence the investing public. 5. We are probably nearing the end of a long term debt cycle.

[LR1400]

I've considered selling multiple businesses, however, I've held off. At times, I consider his a personal weakness. If I get in at a cheap to decent price I really hate selling my asset.

 

As long as earnings support the valuation, I'm going to hold onto the majority of these businesses. They include WFC, CHL, GS, AXP. Previously sold MCD, I thought they had reached full valuation, and T, which I wasn't a fan of as a business.

 

The asset based/book value/Graham type purchases I will sell as they reach book value. O&G based businesses, I will sell when they reach full value again, miners, the same. One recent purchase, NVGS, I will hold until it reaches book value as well.

[Uccmal]

I've considered selling multiple businesses, however, I've held off. At times, I consider his a personal weakness. If I get in at a cheap to decent price I really hate selling my asset.

 

As long as earnings support the valuation, I'm going to hold onto the majority of these businesses. They include WFC, CHL, GS, AXP. Previously sold MCD, I thought they had reached full valuation, and T, which I wasn't a fan of as a business.

 

The asset based/book value/Graham type purchases I will sell as they reach book value. O&G based businesses, I will sell when they reach full value again, miners, the same. One recent purchase, NVGS, I will hold until it reaches book value as well.

 

Makes sense to me. 

 

 

[SharperDingaan]

You might want to consider 50% cash instead of 100%, & the timeframe over which you want to hold the cash.

Also whether this is at the portfolio, or individual security level.

 

SD

 

 

 

 

 

[Uccmal]

I am going to add a couple of caveats to my cautious dissertation above:

 

1) Personal:  I carry quite a bit of margin debt some of which was indirectly used to finance a real estate purchase.  And I live off the dividends.  So, I need to be very careful and am appropriately hedged with a basket of low lying puts as catastrophe insurance.  And I am opportunistically selling some stocks.

 

2) The business cycle has become impossible to decipher due to government intervention.  Early bear, late bull, early bull?  Everything is out of whack.  All we really know is that debt is piling at various levels (including non financial corporations) and stock markets are probably over valued, given the lack of good deals, if nothing else. 

[Cardboard]

I have said a few times that the best hedge is cash and if you are already into cash the second best hedge are SPY Calls.

 

The latter is some crazy thought that I had back in 2013 I think. Essentially, the problem with being into cash is that you are afraid to underperform the market. Well, the calls solve that at a very low cost since volatility is also usually very low when the market is high or when you are having trouble finding bargains.

 

Buying puts or shorting the market is a terrible hedge IMO and trust me, I have tried it before. If you are a good investor and sit on dry powder, you will have no problem making a lot of money by deploying your cash during a panic. The low likelihood that you will time the market right and extra stress of puts, shorts is simply not worth it IMO. Even if you are right on, it will also cloud your judgement when time to deploy cash is right in front of you since you have these instruments that keep on increasing in value. You will kind of hope for the market to keep going down, be too negative and miss on fantastic bargains.

 

Now regarding that latter thought, there are juicy bargains right now in Western Canada and into Canadian preferreds. They are certainly not priced like everything is rosy...

 

Cardboard

[scorpioncapital]

Note Buffett's answer to question #7 a few days ago to some students -

 

Question 7:  What impact have the fixed income markets had on stocks?

 

WB:  Interest rates are to asset valuation as gravity is to matter.  It will take a lot of movement in interest rates (similar to Paul Volcker in 1981-2) before stocks are too high.  The interest rates on 30 year Treasury bonds have declined from 14 ½ % to 2 ½ % from 1982 to 2016.  Recently, the 30 year Treasury moved from 2.6% – 2.8%.  Stocks are cheap if long term rates are at 4%, four to five years from now.  “We are buying more shares than selling everyday unless interest rates move appreciably higher”.  A profitable trade would be to short the 30 year bond and go long the S&P 500 (assuming no margin calls).  But this is difficult to do on a big scale.  Borrowed money causes more people to go broke than anything else. Charlie Munger has said, smart people “go broke from liquor, ladies and leverage”.

 

If even he isn't sure that stocks aren't actually cheap right now and might double from here, how sure are we that stocks are overvalued to be 100% in cash? That seems a radical position as well.

 

Philip Fischer answered the question 'When to sell' in Common Stocks & Uncommon Stocks. If the right stocks are purchased, the answer is (almost) never. In Path to Wealth he elaborates even further and addresses the question of 'overvaluation'. He says even IF stocks are overvalued, an investor in such stocks probably should hold on. He asks the question, 'What are we trying to achieve?' Part of this obviously has to do with your time frame and goals from investing. 

 

However, like Munger and Buffett also mention, leverage can be a killer. The situation I grapple with (and see adjacent thread) is what to do when using some leverage. The conclusion of several wise investors is you should be a little more aggressive on an uptrend in that situation - and even then I wouldn't sell everything. But in a cash account, this constraint is lifted almost entirely.

[DooDiligence]

Very nice post Scorp (I'm holding about 50% cash in brokerage/401K) but I've almost always held larger cash & cash equivalents for deployment when opportunities present themselves (not trying to time markets, just looking for attractive high conviction purchases.)

 

I usually range anywhere from 10% to 60%.

 

Bought NVO recently & will round out my ownership stake if it nears $30. which should leave me at around 45% cash.

 

I don't count cash held in my real estate / renovations account or my emergency fund.

[rb]

I think that you guys focus too much on rates. Rates are not going to move much... the main reason is the amount of leverage in the system, but there are other reasons. Still, stocks still don't look cheap.

 

Let's look at a simple DDM. Say that we're gonna have inflation around 2%, real growth around 2%, and long term rates around 3%. This implies a fair market return of about 8%. So we have:

 

P=E(1+g)/(r-g) => P=1.04E/(.08-.04) => P/E=26

 

So based on those assumptions a fair market P/E should be around 26 (roughly where we are now). That's just the mathematical one though. The real fair P/E is lower because real replacement cost is still larger than the depreciation. So the market is at best fairly valued or somewhat expensive. This under the best of circumstances - low rates and high margins. As I've said, I'm not too worried about rates. What worries me more about that equation are the earnings.

 

Margins are already really high and could easily come down some. Hell you can chop 20% off the margins and they'd still be great margins historically speaking. With the economy moving closer to full employment you can see an increase in labor costs and a decrease in margins. The uptick in labor costs we saw earlier in the year can be an indication that labor markets have already started to tighter. Remains to be seen.

 

Edit: For anyone who really thinks that rates are really gonna move up you can load up on puts on Bunds and OATs.

[cmlber]

Let's look at a simple DDM. Say that we're gonna have inflation around 2%, real growth around 2%, and long term rates around 3%. This implies a fair market return of about 8%. So we have:

 

P=E(1+g)/(r-g) => P=1.04E/(.08-.04) => P/E=26

 

Alternatively, since 8% is just a guess, we could just as easily guess 7% is a fair market return and P/E = 1/(.07-.04) = 33x.  It doesn't strike me as unreasonable to think people would accept 7% returns in a world with the 30 year at 3%.

[rb]

Let's look at a simple DDM. Say that we're gonna have inflation around 2%, real growth around 2%, and long term rates around 3%. This implies a fair market return of about 8%. So we have:

 

P=E(1+g)/(r-g) => P=1.04E/(.08-.04) => P/E=26

 

Alternatively, since 8% is just a guess, we could just as easily guess 7% is a fair market return and P/E = 1/(.07-.04) = 33x.  It doesn't strike me as unreasonable to think people would accept 7% returns in a world with the 30 year at 3%.

It's not just a guess. Historically market return has been about. Long rates + 5%. I you look another way, historical market return has been about inflation +6%. If you keep to those historical norms you get r=8%. But hey if you want to assume that risk premiums diminished then you can assume that r=4% and then we're in for one hell of a bull market.

[Uccmal]

I have said a few times that the best hedge is cash and if you are already into cash the second best hedge are SPY Calls.

 

The latter is some crazy thought that I had back in 2013 I think. Essentially, the problem with being into cash is that you are afraid to underperform the market. Well, the calls solve that at a very low cost since volatility is also usually very low when the market is high or when you are having trouble finding bargains.

 

Buying puts or shorting the market is a terrible hedge IMO and trust me, I have tried it before. If you are a good investor and sit on dry powder, you will have no problem making a lot of money by deploying your cash during a panic. The low likelihood that you will time the market right and extra stress of puts, shorts is simply not worth it IMO. Even if you are right on, it will also cloud your judgement when time to deploy cash is right in front of you since you have these instruments that keep on increasing in value. You will kind of hope for the market to keep going down, be too negative and miss on fantastic bargains.

 

Now regarding that latter thought, there are juicy bargains right now in Western Canada and into Canadian preferreds. They are certainly not priced like everything is rosy...

 

Cardboard

 

Its all kind of individual isn't it.  I have never had any trouble changing the tune from selling to buying.  I would never be in cash though.  Too much timing and guess work involved.  In my situation it is responsible to hedge, cheaply, and with a value bent.  When a panic hits and the volatility to the downside spikes, puts suddenly become worth alot real quick.  For some reason everyone wants them. 

 

I am already deep enough into Western Canada, and Prefs.  If the market tumbles, the price of oil could very well go with it, throwing up even better bargains.  In that case I would just buy more of what I have. 

[John Hjorth]

Just a question here for the gents participating in this topic: What do you consider your investment universe? - Just to get get some further shade on what has been posted in this topic so far.

 

Especially:

 

Cardboard:

 

Do you focus only on North American companies?

 

Uccmal:

 

Same question.

 

rb:

 

Same question, however I have noticed that you have bought BUD recently.