The adage, “cash is king” could be a whole lot more appropriate in today’s market than in recent years. For equity investors, after a strong three and five year bull runs in Canada and the U.S. respectively, recent market volatility have caused a higher degree of uncertainty about keeping your entire nest-egg in the market.
The sentiment is understandable against the backdrop of recent events including the August 24th market “mini-crash” that Fortune Magazine referred to as “one of the biggest one-day declines in recent memory.” In one trading day, the market fell more than 1,000 points intraday.
While the resource laden TSX Composite Index remains down significantly on the year, it is important to point out that in the U.S., the S&P 500 and Dow have already gained back all their losses from that short-term crash. The volatility is a concern, but there should be no panic in the streets.
Holding a portion of your overall portfolio in cash, with broader valuations relatively high and global growth a challenge, is prudent. But given the measly rates of return currently offered by “cash and cash equivalent” investments there are alternatives.
Before we get to one savvy alternative, we will scare you a bit by pointing out a few issues that could weigh on the markets in the near term.
QE3 has Gone the way of the Dodo bird
Last year, the Federal Reserve voted to end QE3, its bond-buying stimulus program. Throughout the stimulus program, the Fed pumped money into the economy, a huge portion of which flowed through the banks and into the stock market. This in turn drove up stock prices.
Many analysts believe this is the primary reason Wall Street has done so well since 2009 despite the fact that Main Street has suffered from very slow growth.
Without the stimulus program boosting the market, it could remain sluggish for a while. Having said this, while the U.S. is reigning in the taps, much of Europe and China are stepping up the stimulus.
Commodity Prices are low
This has been nowhere more apparent than in Canada. While the average Joe or Jane might enjoy a cut in the cost of commodities, this typically doesn’t bode well for investors (Canadian resource investors in particular) or the economy at large. Consider the price of oil, a “pillar of the global economy” according to many analysts, has fallen drastically in the past year. When the cost of oil rises, so do the costs of other commodities, due to its inflationary effect. The inverse is also true when oil prices fall. Subsequently so do the prices of countless other commodities. Stocks are a claim on real assets, so the market responds accordingly when commodity prices are down.
It’s not just about oil either. Gold, silver and platinum are now at five- to eight-year lows, as are basic materials, signaling the construction and industrial sectors are weak.
Of course, the fact that these commodities are all denominated in the surging U.S. dollar also has to be factored in.
Interest Rates Will Rise
Last year, the Feds promised to keep rates near 0% for a “considerable time,” but now it is becoming more and more likely that rates will rise sooner rather than later. This will cause a considerable strain on the market, since low rates encouraged stock market investments in the past.
What can you do?
First off, it is prudent to hold some of your investment portfolio in cash and cash equivalents at present.
However, you can also choose to own stocks which trade at reasonable valuations and are “Cash Rich.” Profitable stocks with huge net cash balances relative to their market capitalizations or the value investors assign to their business. They are the type of companies that can actually benefit, in the long term, from a market downturn as they are perfectly positioned to grow by cheap accretive acquisitions.
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