I want a new drug
One with no doubt
One that won’t make me talk too much
Or make my face break out –
“I Want a New Drug” – Huey Lewis and the News
Cash is a wonderful thing. It provides the holder with liquidity, optionality and in the best of times holds its value against inflation. The problem is that for investors, cash can be a drug. Easy to try, comfortable to use and a difficult habit to kick. As I wrote a few years back:
Most investors do not have the discipline to have a fully thought out strategy for employing cash on an opportunistic basis. For many cash becomes a bad habit. There is always a reasonable claim for another correction or bear market. That is the nature of markets that climb a “wall of worry.” There is ALWAYS something to worry about. The desire to flee to cash to avoid the next 5% downdraft is a gateway to a cash addiction.
The issue isn’t cash, per se. In fact, there has not been a better time to hold cash from a return perspective in the past decade. The issue is that the psychology of cash is difficult one to manage. Josh Brown and Michael Batnick recently discussed this challenge in a video. Josh notes:
The trouble with swinging to cash, even if you end up being right and selling out right before the market falls, is that then you have to get the timing right for when you buy back in. But market timing is hard on both sides.
There is also a change in psychology that takes root in the mind of someone who has just avoided a stock market sell-off. They begin to root for even further declines and see all new developments as potential negatives, rather than positives.
Once you begin rooting for something in the markets, good or bad, you know your investment plan has gotten off track. Ben Carlson at A Wealth of Common Sense delved more into this psychology of holding (excess) cash and noted:
Corrections & bear markets don’t make it any easier to pull the trigger. You would assume it becomes easier to buy stocks when they’re falling but cash is a comfortable place to be during a correction. It’s like you’re tucked in under your warm comforter on a freezing Saturday morning in the winter and you never want to get out of bed.
When stocks begin to fall that comfort can lead to a cash addiction where you keep telling yourself you’ll buy when stocks fall a little further or the dust settles. And each time they fall you move that hurdle to buy just a little higher until you’re never able to pull the trigger.
The stock market is in the midst of a correction. It could very well be headed for a bear market. Many developed and emerging market equities are already in a bear market. If you are holding cash, having waited potentially years for a meaningful correction to buy stocks, now is an opportunity.
The chart below shows the Morningstar market fair value measure from 2007 to today. It essentially aggregates the fair value of all the stocks Morningstar’s fundamental analysts follow. If you put any stock into this measure, it shows that stocks are now cheaper than they have been in a couple of years. Stocks are certainly not back to the grossly undervalued levels seen post-GFC. But they are certainly cheaper than they used to be.
The point isn’t that you should load up stocks on stocks, foreign or domestic. The stock markets may not be done going down. By one measure the equity risk premium rose 50 bp for the month of October. That’s not nothing.
The point is that if you are holding a big slug of cash waiting for an opportunity to put it to work AND you aren’t even considering it at present you have a problem. You have a cash addiction problem. We all know that the first step in addressing an addiction problem, is admitting you have a problem in the first place.