Musings on Cash

We have a client, a very smart physician, who loves to accuse us of market timing.  it is a wounding accusation, given the consistent contempt we’ve offered in our various communications for the idea of getting in and out of the market, based on fear and greed, on reading the tea leaves, even on (heaven forfend) listening to Jim Cramer.

If you sense a humbling confession in the offing, you are roughly on the mark.  But before I get to my pending self-abasement, let me reprise an argument against market timing, in the form of a story about one of my former clients.

Betty attended a class I taught at the local community college, back in the mid-1980s.  Recently widowed in her late sixties, she was taking over the management of her investments for the first time in her life.

She was an excellent student, and went well beyond the material in the basic investment course, asking for and reading more advanced books and articles.  On the basis of her reading and some of my comments in the course, she became convinced that the market was over-valued.  She sold all of her stocks and went to cash in late July of 1987.

Betty absolutely nailed the timing.  Late August was the market high, and within three months the stock market had fallen by more than 36%.  On October 19 of 1987, the market suffered its worst one-day point decline in history, down 508 points or 22.6%.

Did her perfect timing help her to enhance her wealth over time?  It did not.  She was convinced that she had a handle on market timing, and was determined to wait for the bottom before buying back in.

The market’s intra-day low actually occurred on Tuesday October 20, the day after the crash.  She did not buy back in on that day, or any other in 1987.  In fact, when I left the brokerage firm to start our investment advisory practice, more than two years later in early 1990, she was still entirely in cash, waiting for a market low that never came.

Getting the timing of an exit from the stock market correct is challenging.  It is far more likely that you will sell before a market advance, because you are scared, than near a high and before a decline, when market sentiment is positive.

But let’s assume you are considering either a full or partial move to cash when the market is acting well, as it has been so far in 2013.  (I’m ignoring the recent slide.)  Even if you get the sale right, you still have the challenge of getting back in.

Which brings us to the current market environment.  We are concerned about the valuation of the market.  By the measures we follow, the market is not cheap.  It is on the high side of fair value, but not (yet) in bubble territory. So we are in an environment of enhanced risk and constrained opportunity.

More on this in coming weeks.  And Doc (you know who you are), get ready to gloat.


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