The case for cash
By James Grant
Forbes Magazine
Wednesday July 10, 11:16 am Eastern Time
Beating the S&P 500 since before the 2000 stock market top, U.S. Treasury bills are more than just a sanctuary. And now is when keeping some dry powder makes sense.
I write in praise of cash, the interest-bearing asset that doesn't go down. Admittedly, it doesn't go up, either. The average taxable money-market mutual fund yields all of 1.3%, at which rate your savings would double in 54 years. That 1.3% percent is lower than both the rise in U.S. consumer prices over the past year (1.6%) and the meager dividend yield of the 500 (1.5%).
At most markers in the marathon race of investing, cash runs dead last. Gold, the purest form of cash (perfectly liquid and non-interest-bearing), returned 1.2% a year from 1802 to 1997, before deducting for inflation, says Jeremy Siegel, a professor of finance at the Wharton School. Bonds did better, at 4.9%, and stocks did best, at 8.5%.
Why do stocks excel? Because a profitable company is a thing of beauty. It reinvests its earnings. It grows, and its growth is capitalized. Before long, the stock market is willing to pay $25 to $30 for every dollar of net income it generates. And when rising profits are overlaid on falling interest rates, its shareholders are in heaven.
Yet sometimes the shareholders are not satisfied with heaven. They forget that common stocks are not a good investment absolutely; they are a good investment at a price. When bid up to the wrong price, as stocks were in the late 1990s, cash becomes more than a sanctuary. According to Richard Bernstein, the chief U.S. strategist at Merrill Lynch, U.S. Treasury bills have outperformed the S&P 500 for the past 54 months.
A portfolio of Treasury bills is the most conservative investment imaginable. Yet the decision to park one's money in a low-yielding cash equivalent, forsaking all other alternatives, can be highly risky. To a professional money manager, such a decision is anathema. In the late boom, it was a firing offense.
"Speculation," the great Fred Schwed Jr. wrote in his classic 1940 book, Where Are the Customers' Yachts? "is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming a little." In this sense, cash is the ultimate investment. As cash is guaranteed not to go up, it is also warranted not to go down (except, of course, against other currencies or the Consumer Price Index).
To settle for an asset that merely does not go down runs against the grain of a quarter-century of happy financial experience. An investment in cash seems also to fly in the face of simple arithmetic. Almost every investment with a yield outyields cash. What's the point of a dollar lying fallow?
One of the finest value investors, Seth Klarman, the president of the Baupost Group in Boston, Massachusetts, calls cash his "steady-state" investment. Cash is what he holds in the absence of a compelling alternative. Warren Buffett, making the same point, used a baseball metaphor to illuminate the problem of making investment choices. Don't swing at a bad pitch, Buffett counsels; wait patiently for a strike.
When you, the investor, are both batter and umpire, making an objective call is hard. Is the market throwing strikes? Certainly he is coming closer to the plate than he did in the late 1990s, but (for my money) he's still high and outside.
There is no one definitive way to value the stock market. On the basis of a trailing price/earnings ratio, the S&P is prohibitively expensive (42). On the basis of forward earnings estimates, the S&P is merely a little pricey (19). By no reckoning, however, is it really cheap. That the S&P is a lot cheaper than it used to be is small consolation. It used to be uniquely overvalued.
Could an overvalued bull market find solid footing in the valuation neighborhood of "merely a little pricey"? Anyone old enough to vote has lived long enough to appreciate that the market can do anything. But I would call such an outcome unlikely.
Possibly you are seeing exceptional opportunities, even today. If so, should you, nevertheless, keep a little dry powder? Yes, you should, unless you are certain that tomorrow's opportunities will be inferior to today's. (And how can you be certain?)
The search for the best kind of cash-parking space is simplified by the low level of money-market interest rates. For example, the Vanguard Prime Money Market Fund holds corporate and U.S. federal agency obligations and also full-faith-and-credit U.S. Treasury securities. This fund yields 1.67%. The Vanguard Treasury Money Market Fund (as its name suggests) holds only ultrasafe U.S. Treasurys. This second alternative yields less, 1.57%; but for such a small gain, why take even a small risk?
__________________________________________
James Grant is the editor of Grant's Interest Rate Observer. Find past columns at www.forbes.com/grant. |
