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Money Coach

A Lesson on the Value of Cash



Talk about unconventional wisdom.

Investment U. Chairman Mark Skousen went to Las Vegas earlier this year to attend the money show. While there, he asked thousands of investors which they thought was a better bet right now: Stocks that pay little or no dividends. Or, earning five percent in, say, a no-risk money market fund?

Their answers were surprising, if not alarming, to armchair economists. By a wide margin, the group said that the best investment right now can now is a Treasury bill, a money-market fund, or a bank CD. In other words, cash-rich investments.

The fact is that, in today’s environment where economic volatility is as much a part of the landscape as Wall Street, cash has become the wisest and safest investment in town.

Consider Warren Buffett, who has $40 billion of Berkshire Hathaway parked in cash and cash equivalents these days.

Recently, Buffett chatted with PBS’ Charlie Rose and explained why a great stock investor likes to sit on so much cash. He used a baseball analogy. If a player swings at every pitch, Buffett said, he will likely swing and miss more often than not. But a seasoned hitter is more selective, and thus more productive as the pitches he slashes away at are right down the middle of the plate -- turning misses into hits. And sometimes it's best to leave the bat on your shoulders and create a walk out of four bad pitches.

Buffett’s message couldn't be clearer in today's economic and investing environment. It’s better not to invest – or swing – at "bad pitches" in today’s market. You may not hit a home run, but you won’t strike out, either. And you'll still get to first base.

That's the baseball analogy for sitting on cash.

To understand cash investing better, it’s worth noting that Buffett does not bluntly say, “I am sitting on cash because I believe the market is overvalued and will slide. In the future I will buy stocks cheap.” In fact, it's more helpful to avoid listening to what Buffett says and focus instead on what he does.

As one of the greatest gurus in stock market history, Buffett knows that his every utterance can shift the market. He does not want to cause a stock market panic – or be blamed for causing a slide in stock values that may hurt his considerable equity portfolio.

But if you read between the lines and watch what Buffett does with his money, his investment success is fairly easily to emulate.

This year, Buffett-watchers are seeing the Oracle of Omaha move into cash. Millions of savvy investors have followed suit.

But why? The reasons are both numerous and logical. You only need to read the economic tea leaves to understand why.

In the next few blogs, I'll explain why, in the next year, cash will be king.

Reason #1 – A Global Recession Is Likely

You may not hear about it from the Wall Street bulls, but the U.S. is the world’s biggest debtor nation, printing money with abandon to sustain the illusion of prosperity. And we’ve been doing this for years.

In 2005, the US government owed $7 trillion and that number is climbing every day.
For decades, Americans have been told by government, by Wall Street, and by mass media that the economy is just fine, even as the cancer grows below the surface.

Part of that problem is with the deficit. A slew of government and private analysts put the actual U.S. "fiscal gap," (which means all future receipts minus all future obligations,) at $40 trillion (Government Accountability Office) to $72 trillion (Social Security Board of Trustees). The International Monetary Fund estimates the gap at $47 trillion; the Brookings Institution at $60 trillion. To solve the deficit problem the US government would have to stick taxpayers with an immediate and permanent 78 percent hike in the federal income tax.

The story of the weakening dollar—and how it’s the loosened lynchpin in the coming economic recession—is a key cornerstone of this argument. There is ample evidence showing that the U.S. dollar is in a major long-term bear market. Consequently, it’s critical for investors to limit their exposure to the dollar to an absolute minimum. Many are doing so to insulate themselves from a failing dollar and likely recession.

These investors believe that, in general, U.S. equities remain substantially over-valued, and that the major U.S. stock indexes are in the early stages of long-term secular bear markets. In fact, economic policy decisions by the U.S. Federal Reserve is greasing the skids for the stock market’s demise, primarily by flooding the world with dollars and credit. Since 1995, the amount of money in the world has increased almost exponentially, growing an average of $525 billion a year. (For comparison, between 1990 and 1995, the money supply rose a total of $468 billion.)

Most of that money is in the stock market, buying up stocks with no earnings and companies with no prospects. That cash will disappear once stocks start dropping. Meanwhile, a cash flood is also washing overseas. Foreigners are holding nearly nine trillion U.S. dollars. That is a vicious cycle. Less profits means lower stock prices. Just like Americans, foreign investors have watched their stock market wealth disappear. Overseas, American investments are becoming less and less attractive, and foreigners may soon abandon the dollar altogether.

The last piece of the global recession puzzle is real estate, specifically the downward trend of U.S. housing prices in 2006.

There’s no great trick to understanding the current status of the US real estate market. If it looks like a bubble, walks like a bubble, and quacks like a bubble, it's a bubble. The combination of artificially low interest rates, foreign central bank intervention, an irresponsible Fed, excessive credit availability, the proliferation of low or no-down payment, adjustable-rate, interest-only, and negative-amortization mortgages, a can't-lose attitude among speculators, validated by ever rising "comps," the complete abandonment of lending standards, wide-spread corruption in the appraisal industry, rampant fraud among sub-prime lenders, and the moral hazards associated with loan originators re-selling loans to buyers of securitized products who perceive minimal risk and an implied government guarantee, has produced the "mother of all bubbles." As the real estate bubble slowly expands, it's not just real estate speculators and home owners who will suffer, but the entire U.S. economy, its banking and financial systems, and anyone with U.S. dollar denominated savings.

Those who hold cash positions in their portfolios will be among the few left standing.


Published Sep 28 2006, 01:38 PM by moneycoach
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