Keeping cash as a replacement for equities

This is mainly a side effect of the 2008 Global Financial Crisis, in which many people got their fingers burnt. In the following, I have summarised common market convictions and will clarify a few misunderstandings.

1. Not buying as long as people are worried
If you wait for not being worried anymore before buying, you will wait forever. Markets are always worried. In fact, it is a positive mechanism as it keeps the euphoria level (which would signal the end of the bull market) in check. Since 2009 (bottom of the market), we have constantly been confronted with challenges:

The market has overcome each of them. Over the same period of time the S&P500 is up by +670%.

Key take-away for savvy investors: It is not the worry of the day which drives the financial markets. Do not overrate them.

2. Paying too much attention to the latest hot topic
These days, everyone seems to be concerned mainly with 3 topics: 1) Inflation running out of control leading to higher interest rates, 2) FED tapering leading to less support for the financial markets, and 3) China (regulatory crackdown, property sector), leading to an economic slowdown.

Everyone is concerned, and everyone discusses the same topics every day. Analysts have already calculated all possible scenarios, meaning that whatever happens next has already been discussed by someone in the public domain. Therefore, all this is already at least partially priced-in. To illustrate this point, you can think of the day the FED might actually start its tapering programme. It will have no significant impact on the markets (non-event).

Key take-away for savvy investors: Markets react to new and/or unexpected information. They don’t react to information which has already been discussed widely.

3. Underestimating that we are always exposed to negative news
It’s a game, and it goes along these lines: Journalists are paid to sell (their news). What sells best? Negative news! Therefore, there is a constant negative bias in the news flow we are confronted with. It is not the case that nothing good happens in the world, but journalists need to sell their stories.

Key take-away for savvy investors: The same can be applied to the economic world. Pay attention to how many ‘financial gurus’ are systematically calling for a major market top or the next crash.

4. Getting a wrong perception of reality
How many times did we hear that the markets are getting too expensive, and more so every day? This statement is simply wrong. Looking at the valuation of for example the S&P500 (beige line) last year, we see that it remained stable.

Key take-away for savvy investors: Do not blindly trust anyone’s comments. 

5. Timing the market
Trying to time the market is the ultimate losing game. If it was easy, we would all be millionaires and none of us would work anymore. Corrections are always obvious after-fact only. Nobody knows when they will happen and what will trigger them.  

Most investors lack of discipline and will not buy in a phase of market correction. Why? They get scared by the negative narrative justifying why the markets are going down. Remember: journalists are paid to scare you. So you wait for the dust to settle. And once this is the case, the market will have rebounded already:

Key take-away for savvy investors: Skip the idea of timing the market if you don’t have a crystal ball.

Keeping cash as a replacement for bonds

Many investors own cash because of maturing bonds which are not reinvested with the current low yields. If you believe that in six months, or one year, or two years you will be able to reinvest at good rates, you should better think twice: this is a dream, not reality. You need to accept that bonds do not yield anything if you don’t take risks. Therefore, yield-hungry investors may want to analyse the following alternatives:

1. Very defensive reverse convertibles (on equities). Underlyings should be as safe as possible. Indices are better than single stocks.
2. Alternative investments should be considered as a partial fixed income exposure replacement. I refer to hedge funds and the private markets.
3. China is the only market in which bonds currently look more appealing than stocks. I am analysing government and high quality corporate bonds in CNY, as the CNY yield curve is above ‘developed’ currencies. Obviously there is a currency risk, but the fact that the CNY remains stable with all the current challenges in China is a positive sign.

Key take-away for savvy investors: Keeping cash with the intention to reinvest it into the bond market at (sensitively) better rates soon is not a fruitful strategy. Rates may go up, but not significantly. It is time to be creative and replace some bonds with alternative investments. Opportunistically and selectively, defensive reverse convertibles may help as well.