Right now the old adage Cash is King is one of the worst pieces of advice you can get.
The US is printing hundreds of billions of dollars to bail out the financial system. Despite the deflationary pressure that the massive de-leveraging creates, this new and abundant liquidity will cause long term inflation. So the real purchasing value of the dollar is coming under pressure. In addition, interest rates are historically low. If you put $1 million in T bills, you collect $15,000 a year in interest, an income level that is below the poverty line. You can make more money working at minimum wage in California than a millionaire earning interest. And the combination of low interest rates and high inflation implies the value of money declines faster than the interest paid on it, so in real terms holders of cash are paying to have cash balances on deposit. Consequently, cash is not a good investment idea right now.
Simultaneously, stocks are on sale. Yes, the economy is hurting, but the productive capacity of the US is still intact. We are still powerful, we still have innovative, educated work force and strong brands that are dominant the world over. And you can buy some of those best brands at prices that are better than anything we have seen in decades. Some companies trade at 5 times their cash earnings, which implies a 20% cash coupon, vs. 4% coupon on government bonds. These returns, unlike bonds, are not guaranteed, but they are often growing. Other companies are selling at a discount to the liquidation values of their assets, which is tantamount to buying some of their operating businesses for the price of... zero.
At the depths of the Great Depression, 1 out of 12 companies were selling for less than their cash holdings. Last week, it was 1 out of 10. The 12 month P/E ratio of the S&P 500 companies is 10.8. While it was lower in 1983 (7 P/E), short term interest rates back then were 20%, and they are 2% now.
If you do not find stock prices cheap now, with the market pulverized 45% in the last year, then you probably should never own stocks.
I am not suggesting buying shares in companies that are financially unstable. For my fund, Wellcap Partners, I am staying away from businesses that are in debt, or that are unprofitable, and that do not have a strong and durable competitive advantage. Instead I look for market leaders, with a strong position in their industry and solid financial statements. And some of those are trading at fantastic prices.
Predicting what the stock market will do is about as satisfying as drinking coffee with a fork. But the panic will abate. Markets will stabilize. They might move lower from here but eventually prices will converge back to the true intrinsic value of companies, and in many cases those values are substantially higher than current prices suggest.
This is the time to buy stocks, not to be in cash. It has been said that "no battle plan survives first contact with the enemy." Even generals discard their plans when they come under fire. This stock market is in the thick of battle right now. Buy solid companies and like a general in battle, discard further plans. Hold on even if the market drops further and economic news continue to be bleak. Rather than cash is king, the better adage to go with would be the one that says "stocks are seldom cheap and popular at the same time."
Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment partnership.