Is it right to hold cash in the current market environment?
There are some signs that it could be. Market volatility has been depressed for the last year and stocks are trading at all-time highs with interest rates rising.
Considering how long the equity market rally has been going on for as well, it is reasonable to suggest the current bull market could be about to die of old age. There are also indications, however, the market is not going to roll over anytime soon. Economic growth is picking up in the U.S. and Europe--previously the world's most troubled economy -- and even though equity markets do look expensive, some sections of the market are more expensive than others, and there are still undervalued stocks out there.
What's more, if you detract cash from some of the highest valued stocks in the market, such as Facebook (FB, Financial) and Apple (AAPL, Financial), valuations look appropriate.
So what is the solution? Personally, I think it comes back to the old market timing argument.
Market timing is a waste of time
Trying to time the market is demanding, almost impossible and should be left to traders. The market could crash tomorrow, but it could also continue to rally throughout 2018. In this scenario, selling today could cost you plenty of additional gains.
With this being the case, I believe it is appropriate only to hold cash if the cash finds you. By this, I mean that if you sell a holding because it no longer fits in your portfolio but cannot find a suitable replacement, then the cash has found you and it might be wise to hold onto it until other opportunities present themselves.
On the other hand, if your portfolio is full of high-quality compounders, they may look expensive today, but if they still have a bright outlook for growth ahead of them, there is no reason to sell whatsoever. They might seem expensive, but if the market continues to rally and if they continue to compound book value, selling today will only hold you back. If the market continues to push higher, you might come to regret selling.
Let your winners run
Letting the cash find you might seem like a dumb statement to make, but it is an idea I believe is rooted firmly in investment principles. As noted above, trying to time the market is a loser's sport.
Moreover, selling a winning stock just because you want to go to cash generates unwanted transaction costs, a taxable event, and could mean you miss out on further gains.
Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) have, on many occasions, made it clear investors do not need to do anything when it comes to investing, something Munger calls “sit on your ass investing.”
This might seem like a lazy strategy, but it works. If you own a good company, there is no reason to sell just because you think the market is going to go down. If you had sold Amazon (AMZN, Financial) or Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) in 2007, would have you been able to buy back at the perfect point to make maximum gains? It is unlikely.
That said, it could be worth selling those positions you believe have reached maturity. When I say “reached maturity” I mean stocks that have reached your investment target, or the investment cash has not worked out; simply put, it is only best to sell when the underlying business dictates it is a good time to.
A few weeks ago, I wrote an article on the benefits of using compounders to protect your portfolio in all market environments. I think this is a better way to manage your portfolio from uncertainty than selling and going to cash. As I wrote at the time, using Coca-Cola (KO, Financial) as an example:
"Coca-Cola is a heads-you-win, tails-you-don’t-lose-much stock. If the S&P 500 starts to struggle, the company will still produce returns for investors and if the S&P 500 continues to move higher, Coke will rise in line. Think of it as a low-risk market hedge. And it’s not the only one of its kind out there; there are plenty of other compounders with similar traits."
Disclosure: The author owns no stocks mentioned.
