Mike Lipper’s Monday Morning Musings
Cash is a Four-Letter Word
Editors: Frank Harrison 1997-2018, Hylton Phillips-Page 2018 –
We have been instructed not to use foul language in polite communication, (think of another four-letter word beginning with “F”). The time to recognize the biggest danger of a word and the concept behind it is when the word is most useful. That is exactly why I am calling to our subscribers’ attention the word “cash”. It looks like cash will be the only positive major investment class in 2018. Stocks, bonds and commodities, as well as some real estate and most currencies, except the US dollar, will all have a minus sign in front of their performance.
Major brokerage firms and various wealth management groups are heralding cash as the preferred asset class. Yes, it is better to make small positive returns than losing money. I have been studying this question for more than sixty years. Recognizing my historic bias based on my experience of using mutual funds, I use mutual funds as my primary filter. Utilizing the latest available data from the Investment Company Institute (ICI), with numbers as of September 30th, 2018, the aggregate weighted average cash commitment for all long-term funds (equity, hybrid, and bond funds) was 3.2% of assets. Most investment objectives have 5% cash or less as a percent of their total assets. This roughly represents under one year’s regular income production. Those reserves would only allow for a few additional names to be added to their portfolios and therefore would not normally be enough to make an enormous difference in performance. Unfortunately, many funds today are having net redemptions, which can only be handled by judicious selling. Many fund managers are concerned about a sudden surge in redemptions at the very same time of weak prices and limited available liquidity and do not want to commit all their cash to the market. There are two exceptions to the relatively low cash commitments, Asset Allocation Funds (18.25%) and Flexible Portfolio Funds (14.14%). While these funds often appear near the top of the performance parade in a declining market, over a full market cycle they are not even close to performance leaders.
Not only do I pound performance data concerning this issue, but I spend time with senior portfolio managers and presidents of fund management companies. There are all kinds of managers perceptive to future market declines and they often tend to be premature in terms of timing. Rarely do they commit the bulk of their reserves anywhere near the bottom. Matter of fact, when the eventual full recovery happens, they often have not fully committed to the markets moving toward new highs. Why does this occur? Usually the recovery is based on anticipation of favorable changes not currently reported to be in place. Another reason is that emotionally the cash position is providing too much comfort. Buying after a meaningful decline requires some extra intestinal fortitude. Perhaps we should search for fund groups that replace the savior of funds relative assets with a rigorous long-term committed runner.
Recently we were able to restore appropriate equity fund levels to a cash flow account. This is an example of the advantage that some institutional accounts have over a fully committed personal account. Further, I suggested to a younger subscriber that he commit half of his cash reserves over the next six months to meet his retirement capital needs.
This post focuses on cash allocation as an input to a performance focused portfolio, which could be a semi-permanent element of portfolio management. There are other cash buckets such as planned external cash expenditures and purely opportunistic cash awaiting near term deployment. I do not know which cash bucket was used on Friday. Some of the financial sector stocks I follow showed transaction volume being 50% to 100% greater than Thursday’s volume. Friday’s combined NYSE and NASDAQ share volume was the highest since August of 2011. To me, it is more interesting to guess the motivation of buyers who are making commitments than sellers who are giving up. Traditionally, market analysts view this type of transaction volume as stock moving into stronger hands capable of tolerating currently perceived concerns.
For several long-term accounts that have periodic external payment needs, I have suggested that once a cash commitment is made it should be separated from performance analysis. This anticipates the actual expenditure but does not factor it into the asset allocation analysis.
What to do Now!!
- Determine whether the resignations of General Mattis and the chief envoy to the anti-ISIS coalition are signs of continued political disruption which are of greater concern than trade issues.
- Recognize that some of the signs of short-term capitulation appear to be evident, including Friday’s spike in trading volume led by stock price declines of former large “tech- leaders”. These stocks fell about 5% on Friday compared to 3% for most other stocks. The greater declines of NASDAQ stocks relative to NYSE stocks were probably the result of less liquid OTC trading books.
- In a measure of price movements for the week, a chart in The Wall Street Journal showed that only 19 out of 72 price indicators rose, eight of them being currencies.
- One measure of market sentiment is the often-mentioned American Association of Individual Investors (AAII) weekly sample poll of responses to the question of market direction for the next six months. The current reading showed that most of the sample were bearish or bullish, with a decreasing number being neutral. This is essentially a prediction of continued high volatility. Supporting this view are the 25 best performing funds for the week, six of which were invested in Futures, a leveraged way to bet on fast movements during a short period of time.
Looking to the Future
Long-term value-oriented investors should change their focus away from expected current earnings reports. The great John Neff of the Windsor Fund developed his thinking as to the ultimate earnings power of companies during “normal” times. This allowed him to buy good companies at remarkably low price/future earnings ratios compared to high P/Es on declining earnings. This strategy worked for many years, both for the Windsor and Gemini funds.
Growth oriented investors would be wise to review the current issue of Barrons, which had a long article on a Venture Capital Round Table. I found two items of great interest. The three participants were investing in their expectation of future disruptions to various economic sectors: Financial Services, Supply chain Management, and Farming. To show how far out into the future their thinking extended, there was a discussion on manufacturing products in space, which they saw as a new commercial frontier. As a student of the market, the second thing I found of interest was that one of the three was a successful portfolio manager of an open-end mutual fund, T Rowe Price New Horizons (*). To some degree he and other open-end funds are investing in private companies because of the reduction in the number of attractive publicly traded small and mid-cap companies. Many of entrepreneurial companies are now waiting longer to go public.
(*) A long position is held in client and personal accounts.
Did you miss my past few blogs? Click one of the links below to read.
https://mikelipper.blogspot.com/2018/12/news-focus-may-drive-investment-success.html
https://mikelipper.blogspot.com/2018/12/investment-memory-friend-or-foe-answer.html
https://mikelipper.blogspot.com/2018/12/worries-2nd-derivative-3rd-degree-and.html
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