• Ben TeSelle

Dorato News, October 2021

Portfolio Issues - Cash

Cash is a wonderful thing. Like a good pillow, it’s nice to have when you need it. But also like a good pillow, you don’t want to need to take it with you everywhere. This will be one of those healthy financial habits articles, the kind that are similar to the eat-your-vegetable articles of the nutrition world.

If you know you have an expense you need to meet within the next year or two or three, cash is what you want. Also, for a household emergency account, cash is the ticket.

On the other hand, in investment accounts, cash is rarely a good option. On the margin it’s fine, but you don’t want to have large chunks of cash in an investment account. With investments such as stocks, time is working for you. Companies will grow over time, increase their earnings and pay higher dividends, and stock prices will reflect that.

But time is the enemy of cash. That’s because cash never keeps up with inflation. So it may not be obvious, but you lose a little bit of value every year with cash. And in times of high inflation, you lose a lot of value.

Governments throughout history have allowed inflation, to varying degrees. Ours is no different. So any cash you hold as a long-term investment will always be a losing proposition.

This is why we yammer on about not trying to time the market. Investors who get scared and sell their stocks tend to stay in cash. And those are the investors who lose over the long term. That’s a club you don’t want to join.

“I know a bathtub full of cash is a bad investment, but I do enjoy rolling around in there.”

Market View - Ditto

Nothing much has changed since we wrote the last newsletter in late June. Big technology stocks are too expensive, investors are taking on too much risk in the bond market as they stretch for higher yields, and on some days the stock market resembles a casino more than a reasoned weigher of worth. We suppose that can happen, that nothing of importance changes. Three months is a pretty short time, if you think about it. Of course the financial news shows would never utter such a thought; but they’re more focused on trading than investing, in our opinion. Long term in that environment means sometime after lunch.

We admit that we’re getting a bit tired of the current state of affairs, in which big technology stocks continue to rise and the stocks of many other good companies go sideways or fall. We’ve discussed between ourselves whether the world has changed and we no longer understand it. Perhaps diversification no longer makes sense, and investors should simply plow all their money into the largest technology companies. But every time this type of situation has occurred in the past — think the Nifty Fifty of the early 1970s, or the technology and telecommunications companies of the late 1990s — those investments have subsequently provided horrible returns. So we are sticking to our beliefs. Current and future earnings, and reasonable assumptions about what those future earnings look like, will ultimately determine stock prices. People forget that from time to time, but the reminder always comes.

So what should you expect for the next several months? Our view is that the current investing climate is unsustainable. Investors are too optimistic about the prospects for Amazon, Apple and the like. But we can’t tell you when that will turn. Investors in Chinese stocks were recently reminded that the Chinese government has the power to make or break entire sectors of the economy. Stock prices of private tutoring companies dropped 80% when the government expressed its displeasure with anyone profiting from education. Catalysts can come out of anywhere. In the US, our guess is that the large fast-growing companies will start to disappoint investors with slowing earnings. But whether that’s one month from now, three months from now, or six months from now, we don’t now. We’re surprised the current climate has lasted as long as it has.

Perhaps tax rates will be a catalyst. It seems highly likely that tax rates will rise in the US in the near future, and in particular the corporate tax is likely to rise from 21% to 26%. We may also see a minimum global tax rate. Both of these changes would dent the profits of global, profitable companies. Investors undoubtedly are aware of these tax changes, but for now they don’t seem to care.

Stock investors also seem remarkably unconcerned about inflation. In the bond market this year, inflation-protected bonds have performed about 5% better than standard bonds, a sign that at least bond investors are worried about inflation. It seems curious that stock investors do not yet appear to have similar concerns. Perhaps they think companies can simply pass on price increases to their customers. Who knows? But that mindset is probably a bit too optimistic. The ability to raise prices will vary across businesses and sectors, but very few companies will be able to raise prices without any consequences.

So we think you should expect some turbulence ahead. Not a Covid cliff-drop, as in 2020, but a batch of bumpiness seems likely.

As always, stick with your long-term stock and bond allocation. Some things don’t change much, and your allocation is usually one of those things. Markets fluctuate; you don’t need to.

Sources: Economist, Wall Street Journal, Value Line, Vanguard, Applied Finance Group

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