With Stocks So High, Should Investors Move to Cash?

Link to article: With Stocks So High, Should Investors Move to Cash?

As stock indexes hit record highs, nervous investors increasingly face a difficult choice: Do they keep betting as heavily on the markets, or do they move more money into cash? 

The answer isn't so simple. 

Cutting exposure with the aim of putting cash back to work when valuations drop can be soothing at first, but maddening if stocks continue climbing. What's more, many nonprofessionals don't have the expertise to accurately gauge valuations. 

And there is a fine line between adjusting exposure based on valuations and timing the market, which few individual or professional investors have done successfully. 

Eric Cinnamond of Aston/River Road Independent Value is among a small group of mutual-fund managers who are comfortable letting cash pile up in their portfolios. 

He believes small stocks are "outrageously expensive" and have significant risk. But his fund's huge amount of cash—around 70% of assets recently—is earning almost nothing, hurting performance as markets move higher. 

For investors who are considering such a strategy, here are a few things to keep in mind.

MOI Best Ideas Conference 2014 Presentation/Book

From ValueWalk: MOI Best Ideas Conference 2014 Presentation/Book 

How the 'PayPal Mafia' redefined success in Silicon Valley

Link to article: How the 'PayPal Mafia' redefined success in Silicon Valley

The PayPal Mafia -- a term that's used with affection and awe in Silicon Valley -- is defined as the Mountain View PayPal team either pre-IPO or pre-acquisition, depending on which founding member you ask. While those may seem like vastly different stages in a company's life, it's more like splitting hairs as PayPal's IPO happened only a few months before it was acquired. Former PayPal CEO Peter Thiel estimates the PayPal Mafia to be around 220 people. The PayPal Mafia does not include 700 person customer service operation that was running in Omaha, Nebraska at the time. 

That group of 220 people went on to create seven distinct "unicorn" companies. Unicorns are companies with a valuation of more than $1 billion.

Hussman Weekly Market Comment: Quotes on a Screen and Blotches of Ink

Link to: Quotes on a Screen and Blotches of Ink

Implied volatility in S&P 500 index options fell to just 10.3% last week, indicating enormous complacency about potential risk. I’ve noted before that extreme overvalued, overbought, overbullish conditions tend to feature “unpleasant skew”: the raw probability of an advance is typically greater than the probability of a decline, so the market tends to achieve a series of successive but fairly marginal new highs, which can feel excruciating for investors in a defensive position. The “skew” part is that while the raw probability favors an advance, the remaining probability often features vertical drops that can wipe out weeks or months of market gains in a handful of trading days. We’ve certainly seen an unusual persistence of overvalued, overbought, overbullish conditions without consequence in recent quarters, but it is notable that the implied skew in S&P 500 index options has soared. Indeed, the ratio of implied skew to implied volatility spiked to the highest level in history on Friday. Again, we’ll quietly state our case here, with an understanding that there is little use in waving our arms about.

Again, on a broad range of historically reliable measures, our estimate of 10-year S&P 500 nominal total returns is now less than 1.8% annually. That said, the most reliable measures actually project negative returns, but then, the most reliable measures are those that adjust most fully for cyclical variations in profit margins, and we are continually reminded that this time is different. The ratio of market capitalization to GDP, which Warren Buffett (correctly) observed in a 2001 Fortune interview is “probably the single best measure of where valuations stand at any given moment” is now about 150% (not just 50%) above its pre-bubble norm, even imputing a rebound in Q2 GDP growth. Of course, Buffett also wrote "A group of lemmings looks like a pack of individualists compared with Wall Street when it gets a concept in its teeth" - which may explain why Wall Street seems so entranced with the concept of QE instead of actually doing the math. The ratio of market capitalization to GDP, presented below on an inverted scale, is beyond every point in history except for the final quarter of 1999 and the first two quarters of 2000.

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Last week, the Bank for International Settlements, which acts as the central bank to central banks, issued its annual report. It is about the most insightful warning that one is likely to see from the central banking system, even if the Federal Reserve, ECB and other individual central banks are the ones being warned.

“Financial markets have been exuberant over the past year, at least in advanced economies, dancing mainly to the tune of central bank decisions. Volatility in equity, fixed income and foreign exchange markets has sagged to historical lows. Obviously, market participants are pricing in hardly any risks. In advanced economies, a powerful and pervasive search for yield has gathered pace and credit spreads have narrowed. The euro area periphery has been no exception. Equity markets have pushed higher. To be sure, in emerging market economies the ride has been much rougher. At the first hint in May last year that the Federal Reserve might normalize its policy, emerging markets reeled, as did their exchange rates and asset prices. Similar tensions resurfaced in January, this time driven more by a change in sentiment about conditions in emerging market economies themselves. But market sentiment has since improved in response to decisive policy measures and a renewed search for yield. Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally.

“In the countries that have been experiencing outsize financial booms, the risk is that these will turn to bust and possibly inflict financial distress. Based on leading indicators that have proved useful in the past, such as the behaviour of credit and property prices, the signs are worrying.

Links

Bob Rodriguez Speech: Fed Policy And Dodd-Frank (LINK)

Andrew Smithers: When to underweight US equities (LINK)

George Cooper: The Economic Plane (LINK)

Nicholas Kristof: When They Imprison the Wrong Guy (LINK)

Good Fences: The Importance of Setting Boundaries for Peaceful Coexistence (LINK)

Ed Catmull: Creativity, Inc.

Link to video

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Book: Creativity, Inc.: Overcoming the Unseen Forces That Stand in the Way of True Inspiration (Kindle format, Audio CD)

Related link: Ed Catmull interview at the Stanford Entrepreneurial Thought Leader Seminar

Related previous post: Finally: A Business Memoir That Owes More To Nassim Taleb Than To Jack Welch

[H/T Will]

GR-NEAM Reflections: 07/01/2014 - Mammoth in a Tar Pit

Link to: Mammoth in a Tar Pit

The view that deleveraging in the U.S. is complete misses the point. Repeated bouts of government-supported credit creation are colliding with each other and declining in effectiveness.

Fortune's Carol Loomis to retire

Link to article: Fortune's Carol Loomis to retire

Not only is she the longest-serving employee at Fortune, but she’s also arguably the greatest business journalist of our time. And now, sad to say, Carol Loomis is saying goodbye.

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Related book: Tap Dancing to Work: Warren Buffett on Practically Everything, 1966-2012: A Fortune Magazine Book

Guy Spier on why it may not be best to publicly discuss current ideas...

From Guy's 2013 Annual Letter:

In recent years, I’ve found that it works better not to talk publicly about current holdings in the fund. This is not a matter of guarding our secrets to prevent other investors from stealing them. The real issue is that, once a person has made a public statement, it’s psychologically difficult for them to back away from it — even if they’ve realized that their stated opinion was wrong. In his seminal book The Psychology of Influence, Robert Cialdini called this the “commitment and consistency principle.”

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Related book: Influence

Related previous post: The mistake of consistency

Abe’s third arrow, the second time round - by Andrew Smithers

Link to article: Abe’s third arrow, the second time round

Abenomics, the term given to the reform package Japanese prime minister Shinzo Abe launched to revive the country’s economy, is based on two myths. One is that the economy has performed badly and the second is that this non-existent failure has been due to deflation. Despite its lack of intellectual justification, the attempt to stop deflation has been a success as the accompanying rhetoric and monetary policy have produced yen weakness. This was an essential step towards solving Japan’s fiscal problem and, as the rhetoric has been about deflation rather than devaluation, the dramatic weakness of the currency has been achieved without international opprobrium. 

Over time the devaluation should result in an improved current account. This will allow the fiscal deficit to fall while the economy moves ahead, but it is not enough on its own. The other essential is to reduce the cash flow surplus of the business sector. Having achieved success in step one, largely by accident, there is a chance that Abenomics will succeed in step two. If it does, it is again likely to be an accident.

Mr Abe has announced that corporation tax will be cut sharply. This was heavily leaked in advance but the details, which are crucial to its effect, remain unknown. This obscurity extends to the purpose of the change as well as to its implementation. Past announcements suggest that the aim is to encourage higher growth through higher investment. This is absurd. Japan invests too much at home and the return on new capital is, therefore, depressingly low. Encouraging higher investment is like asking water to flow uphill. (For details, see my recent presentation to the Bank of England’s Chief Economists Worksho: “Abenomics – Myths, Rhetoric and Reality”.)