Current Market Conditions And Is Cash Trash?

Hey, The Investor’s Podcast Network Community!

I want to start out this month’s newsletter with a quote from Ray Dalio. At the recent World Economic Forum in Davos, Switzerland, he said, “Cash is trash.”

This might surprise you. Why shouldn’t we have plenty of cash in our portfolio? Everywhere I go, I hear people talking about preparing for the stock market to crash. 11 years into a strong bull market, not even a trade war with China or geopolitical issues can seem to stop the long-term bull trend.

I don’t know when the crash will come. It can happen tomorrow. It can take years. Nevertheless, I’m 100% sure that it will eventually happen. On the other hand, I’m also 100% sure that if you completely ignore the risk of a crash and remain 100% in stocks, you will still do well. I’ve talked more about this strategy here in my previous newsletter from November.

As all stock investors know, it’s hard to predict the erratic movement of the market, especially in the short term. I, for one, wasn’t 100% in cash and plowed all of it into the stock market when the Dow was trading at 6,547 in March 9, 2009 (when it closed at a 12-year low). I’m also confident that I won’t be 100% in equities the next time the stock market closes at an all-time high, only to go fully into cash. If you meet someone who tells you they can do that, I suggest you run away as quickly as you can.

But what is the implication for us as active investors? We surely can’t stay ignorant of the fact that all major asset classes look overpriced across the board, right?

No, the key is to understand the different approaches to how you can position yourself, and the pros and cons of doing so. Although it won’t help you predict the future, you can intelligently prepare yourself while still being invested in the market.

Let’s go back to the quote of Ray Dalio. I think he has a point. Cash is indeed trash. You don’t want to have too much cash in your portfolio, because it has no yield and it loses purchasing power every single year due to inflation. Please keep in mind that I’m not talking about the official inflation numbers that are artificially kept low, because those keep government payments like social security and Treasury Inflation-Protected Securities low too. I’m talking about the real inflation that the average citizen experiences when he or she is looking at the growing expenses for housing, transport, education, and healthcare. That is real inflation. And real inflation is eating into the purchasing power of cash, no matter what the official inflation number states.

With all the bad things you can say about holding cash, the upside is that it gives you optionality to easily put it into investments in the future. And while inflation is slowly chipping away cash’s value, it suddenly looks a lot more attractive when the stock market plummets. Warren Buffett seems to agree. Aside from Berkshire Hathaway’s numerous subsidiaries, Warren Buffett holds $214B in publicly traded stocks, and $128B in cash and cash equivalent (primarily short term bonds).

I don’t think it’s ever a good time to be fully in cash — not even at a time with outrageous valuations like today. However, I would also not suggest you to aim for the complete opposite. The opportunity cost of either extreme is just too high.

You may want to consider diversifying outside of the US where stocks are not as expensive. Emerging Europe, for instance, is priced at a 10% return, and emerging markets overall are priced close to 7%.

Considering where we are in the cycle, another investment to complement (not replace) cash and equities are hard assets. Hard assets come in many shapes and forms  — buildings, equipment, gold, oil, etc. In the same interview where Ray Dalio said that cash is trash, he specifically advocated for diversifying into gold.

Why would he say that? The advantage of hard assets is that they maintain their value regardless of which currency denomination society uses. Therefore, hard assets are a hedge against real inflation and/or a crash in financial markets.

Including hard assets in your portfolio seems even more appealing if we dig a little deeper and analyze how the monetary system will react in a recession. We already know that the FED has close to none of its most useful ammunition to stimulate the economy. They simply can’t lower the interest rate as they did from September 2007 to December 2008 when it went from 5.25% to 0.25%. We also know that the more debt is accumulated, the more money is needed to stimulate the economy and mitigate the pressure of austerity and debt defaults. Now, also consider that as much as the Central Bank wants to manage the economy by printing more money (and they will be printing a lot more money), they can’t fully control credit contraction and expansion. Just look at Japan. They have been struggling with this for decades.

It’s essentially the banks and other lenders in society who decide who is creditworthy, based on the person’s income and net worth (relative to the size of their debt payments), together with his willingness to incur debt in the first place. When asset prices fall, you have a self-reinforcing negative effect where forcing economic activity by the Central Bank won’t be possible. If some of this sounds a little confusing, make sure to check out this episode. Preston and I discuss these concepts in detail there.

So what happens next? I honestly don’t know, but I do know that it won’t be pretty once the debt situation unravels. I suggest that you consider protecting your portfolio by diversifying (not replacing) it with more international stocks. You can also load up on hard assets, and make sure you have a little cash on the side too.

You can find our latest intrinsic value assessment for a small German company here. Yes, in times like these, you need to be a little creative. You can also find all of the intrinsic value assessments Preston and I created with our team here.

Have a wonderful weekend!

Your Friend,

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P.S. I’ll be hosting free events again for the TIP community in the next few months. On the 11th of February, I’ll be in Los Angeles, California and on the 28th of April, I’ll be in Cleveland, Ohio. Our good friend Tobias Carlisle will be joining us in Los Angeles.

For our free main event at the Berkshire Hathaway Annual Shareholders Meeting, which happens on the first weekend of May 2020, please check this page out.

You may also sign up directly to any of our events by sending an email to contact@theinvestorspodcast.com.