In today’s edition of The Daily Reckoning Australia, Jim homes in on what he regards as the most underrated asset class of all: Cold, hard cash.
Choosing to allocate a portion of your portfolio to cash may seem boring or unsexy.
But as Jim explains below, it could allow you to pivot into other, more ‘exciting’ asset classes…
Read on for more.
Until next time,
Cash Is Underrated
Markets always contain some element of uncertainty, but that element is stronger at certain times than others. Right now, we are at one of the most uncertain stages since 2008. Growth is slowing, politics are heating up, central banks are confused, and rumours of war are circulating.
Market forecasts must be set against a background of increasing political uncertainty at home and abroad. The major political stress points are well-known, but the implications are less clear. These stress points include currency wars, trade wars, impeachment, the 2020 elections, and international hotspots including Iran, Syria, North Korea, Venezuela, Ukraine, Russia, and China.
Unexpected meltdowns in any one of these arenas could produce market turmoil. Meltdowns in two or more could trigger a global liquidity crisis worse than 2008.
This does not mean investors should run and hide. We are not helpless.
On the contrary, investors must be vigilant and aware of new developments, and have a portfolio backup plan at the ready. This includes an allocation to cash.
Cash is the most underrated asset class of all
Cash is routinely disparaged by investors because of low yield. Actually, real cash (like money in your wallet) has no yield; it’s not supposed to. To get yield, you have to take risk.
Putting money into ‘cash equivalents’, such as money market funds and bank deposits, is not risk-free. Money market funds can suspend redemptions (as happened in 2008) and banks can be shut by government orders (as happened in the US in 1933, in Greece in 2015, and in Cyprus in 2013). Treasury bills owned directly are the best type of cash equivalent with the least risk.
Still, cash has other qualities that make it a valuable asset class despite the low yield. Cash is an ideal deflation hedge. It reduces portfolio volatility, and it has huge embedded optionality. Let’s take those factors one at a time.
In inflation, cash is worthless. In deflation, the opposite is true; cash is worth more. Deflation cannot be ruled out. The current disinflation could slip into deflation.
Central bankers admit they have no tools to deal effectively with deflation. Money printing alone does not work without a change in investor expectations, and deflation tends to reinforce the view that more deflation is on the way. Cash is one of the few asset classes that gain in a deflationary environment.
Cash is also the opposite of leverage when it comes to impacting gain or loss in a portfolio. Leverage will increase the nominal value of an underlying gain and increase an underlying loss. It’s an amplifier. Cash neither gains nor loses in nominal terms; it’s always worth par.
A portfolio with volatile assets such as stocks, bonds, and gold will exhibit less volatility if it also includes an allocation to cash. By reducing volatility, cash can help investors sleep at night, even if they have other volatile assets in their portfolios.
Finally, cash gives you the optionality to pivot into other asset classes once market signals become clearer. If inflation takes off, the investor with cash can pivot to gold or real estate. If deflation takes hold, the investor with cash can pivot to utility stocks, bonds or other assets that are robust to deflation. And, if markets collapse, the investor with cash can go shopping amid the wreckage and pick up bargains.
The investor with cash has optionality to make all of these adjustments. The investor who is fully invested with little or no cash will find him or herself ‘locked in’ to specific asset classes and may suffer losses with no ability to pivot. Too few investors understand these hidden benefits of cash.
All the best,
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