When to Steer Your Available Cash Away from Stocks and Bonds

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Every so often, financial advisors stress how important it is for investors to hold cash instead of jumping into the markets. The intensity of their recommendation and the amount of cash they recommend investors set aside will vary with market conditions.

An August 19 Washington Post article by financial reporter Jonnelle Marte claims financial advisors are now urging investors to step up the amount of cash they ordinarily sock away. According to the most current professional wisdom, since stock prices are at all-time highs and bonds are paying dismal yields, investors are better off on the sidelines holding ready cash in anticipation of a saner market opportunity.

New stock market highs are rolling ou t at a rate of once or twice a week. Diving into stocks at this juncture is akin to rolling the dice. Even normally eager brokerage houses like Prudential, Goldman Sachs and Charles Schwab are recommending investors take a breather.

Referring to the stock and bond markets, Prudential Financial market strategist Quincy Krosby said, “There’s a worry in the market that they’re both overpriced…..That’s why you’re seeing more holdings in cash and gold.”

But could it be possible the stock market is getting ready to scale new highs instead of getting ready to tank? After all, the S&P 500 has already done so at least ten times since the middle of July. But Howard Silverblatt, senior index analyst for S&P-Dow Jones Indices, thinks stocks can’t go much higher without some robust earnings growth.

One clue as to our current situation lies in the PE ratio, traditionally a significant metric for investors that reveals how the price of a company’s stock compares to its earnings growth. As this ratio increases, so does the price of the stock. The long-term price/earnings (PE) ratio for the S&P 500-stock index has averaged out to sixteen. Before they pull the trigger right now, investors need to realize the current ratio is above twenty.

Ordinarily, prudent investors looking to avoid buying too-pricey stocks have the option of parking cash in bonds for a safe, long-term return. But bond yields now are atrocious. A ten-year Treasury bond pays about 1.6%. At that rate, it would take investors forty-five years to double their money. In 2001, when 10-year Treasury Bonds paid almost five percent, investors could double their money in fourteen years. The current financial markets, then, offer quite the dilemma. Should investors jump into stocks at unprecedented high prices?  Should they tie up their cash in bonds with anemic yields for years on end? Or should they just hold back, and play a wait-and-see game?

The answers some of the financial consultants are giving range from sensible to silly. For instance, it can make sense to sell some stocks that have performed well, but are nevertheless looking high-priced right now.

But the advice of Richard Dale Horn, senior vice president of wealth management for UBS Financial Services, seems to me a bit misguided. He recommends, if you’re not sure whether the stock market is going up or down (can anybody be sure?), don’t just throw your residual cash into the market. Invest a little at a time, month by month.

How ludicrous! Why would you take that chance at a market top when the price/earnings ratios of your stocks are clearly at all-time highs? In that case, a little cash at a time amounts to the financial equivalent of death by a thousand cuts.

If you’re not yet retired, the classic formula of six months of cash on hand for living expenses in the event of an emergency seems adequate. Otherwise, you need to gauge the amount of cash you’ll need according to your Social Security, pension and/or 401(k) benefits.

Also, at least several of the financial advisors quoted in the Post article need to wake up and smell the coffee. Gold is in a new bull market this year, but is not even close to the top of its game. Commodities analyst Andrew Hecht observes traders ahead in their gold positions have been taking profits, causing the shiny metal to inch down to an attractive price just above support level.

With stock prices at all-time highs, bond yields at abysmal lows, why would anyone not want to take advantage of an investment that’s negatively correlated to both, and which has a promising upside? If you’re truly looking for a safe place to park cash, one that will protect its buying power over the long haul, you can’t do much better than physical gold.

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