The Occasional Necessity of Holding Cash

“…cash allows you to retain wealth with an eye to being opportunistic at that moment that no one wants the things that are now so popular.”

Jim Grant
Grants Interest Rate Observer

Over 30 years of market ups and downs, we have learned the subtle wisdom contained in this thought. Let’s demonstrate this in practice at LeConte Wealth.

Our clients entrust us to make wise investment decisions for them. As fiduciaries, we take this responsibility seriously. This leads us to conduct a global hunt for prudent opportunities. As value-oriented managers, we like to drive a hard bargain before we put client funds on the table.

Most of the time, we can find something, someplace that fulfills our stringent list of requirements but on occasion we walk away with our cash in hand. Either we already have enough allocated to the best opportunities or the opportunities that we find are too expensive and therefore too risky. It’s an uncomfortable feeling to sit on cash when clients pay us to invest it.

We employ a disciplined, fact-based methodology to evaluate our existing investments and any new opportunities that we are considering. If we see potential for decent risk adjusted returns, we buy (or hold what we own). When the prospective risk adjusted returns shrink, we sell down that position or wait before adding a new position. This sounds like boring, common sense stuff that normally just requires a reliable methodology to calculate risk and return. It gets very hard when your rules tell you to sell something when there aren’t many good places to reinvest the proceeds.

Without getting too technical, the LeConte list of “awesome investment” opportunities is shrinking day-by-day this summer.

US stocks are at valuation extremes when we comparing stock prices to actual sales and earnings (not forecast sales and earnings which are terribly inaccurate).

S&P 500 Price to Sales Ratio

Foreign stock opportunities offer better valuations but this is due in part to the artificial stimulus from negative interest rates and Brexit vote fallout. In our equity models, we have used these events to build our foreign allocation at what we view as deep value prices. We are satisfied with our foreign allocation (both is size and composition) so we are waiting for fresh political and economic data before adding more.

Precious metals have been a big win in 2016 and we have pared back this allocation twice to keep it in line with our risk profiles. Finally, global bond markets have performed better than stocks by benefitting from economic uncertainty and negative interest rates. We have trimmed our exposure to lower rated, higher risk bond sectors to lock in the gains.

The profits that we have realized have left us with a lot of cash right now. If markets remain at elevated levels, we will continue to realize gains and build this cash position into the Fall. There are times when the safety and certainty of cash is preferred to taking unknown risks and deploying it.
To invest in most asset classes now you HAVE to be right. There is no margin for error. We find comfort when our actions are tilted towards the minority view of things. Jim Grant also said,

“Successful investing is about having people agree with you … later.”


The Stock Market's Problem in One Chart.

After Janet Yellen was confirmed Federal Reserve Chair Person in February 2014, she quickly halted the Feds "Quantitative Easing" asset purchase programs. The effect of QE on stocks is visibly discernible in this FRED chart.

Options for stock investors - Pick one:

1. The Fed restarts QE (not likely)
2. Congress passes a "helicopter drop" stimulus bill (less likely)
3. Stocks remain stagnant until economic activity materializes (probable)

Yellen has been a dogmatic proponent of Income equality. She is very unlikely to restart QE. There is no chance congress does anything in an election year and earnings weakness has stock range-bound. You have to believe that the US economy is strong enough to accelerate in the midst of economic weakness across the rest of the planet to be positioned for bullish "risk on" trades right now.

Staying Clear of the Blast Radius

“The more you sweat in times of peace, the less you bleed in war.” General Chiang Kai Shek of China

China is having a tough time right now. The Shanghai Composite has dropped 35% in less than a month. When 80% of a market’s participants are retail investors speculating with borrowed money, this sort of volatility shouldn't be surprising.

The decline has erased more than 3 trillion dollars of gains. Compared that to the Greeks attempting to renegotiate payments on a paltry 60 billion Euros of debt that mature in the next 5 years. After this decline, the Shanghai market is still up for the year (as the S&P 500 turns negative for the year).

As second quarter earnings season gets underway this week, we learn if US companies took appropriate measures to minimize the effects of these global problems. By comparing the European and Chinese economies to the US, it’s unlikely that they are outside the blast radius of these events.

The time to enact safety measures to protect against this sort of volatility was a last fall when the European Central Bank, concurrent with the end of Quantitative Easing in the US, initiated their own stimulus program.

The Peoples Bank of China (PBOC) is sweating out their market decline by announcing several rushed solutions that are destined to exacerbate problems. Short term selling restrictions offer temporary relief but real price discover will occur when (and if) they lift them. Time will tell.

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