What Not to Do: Thinking about a Crash Versus Planning for a Crash
In today’s Money Morning…where the market is right now and the ‘cash’ problem…this superannuation guru said it…cashing up to go again and reviewing funding risks…and more…
There’s a famous half-time speech by an AFL coach in the 1975 Grand Final which is based on the mantra, ‘Don’t think, do!’
And there’s a lot to be said for that mentality in the world of investing.
You can um and ah as long as you like but inaction is frequently crippling.
So today I’m going to outline the current state of the market and highlight a tool that’s useful for planning for a crash.
While I don’t think a crash is looming on the immediate horizon, it’s a good thought experiment to conduct so that you’re nimble when the time comes.
Here’s the current state of affairs in the market today.
Where the market is right now and the ‘cash problem’
A quick recap:
- Huge rally for commodities
- Renewables push
- Inflation fears growing
- Crypto crash (winter?)
- Central bank-backed digital currency (CBDC) rollouts
- Wind coming out of the sails of growth stocks led by…
- Fear of rising bond yields
- Mountains of debt created by stimulus
- Continued trade tensions (China)
- Uncertainty over vaccine effectiveness
- Stretched valuations (Schiller ratio)
- Ultra-low or even negative interest rates
Though not exhaustive, it’s a lot to take in, and we’ve covered all of these topics in great detail in Money Morning.
The trick is synthesis and coming to a course of action.
From the bear playbook, you could focus on just a few of these things and conclude that sticking in cash is best.
Or alternatively, you could attempt to profit from a crash you are convinced will happen by say, taking a position in BetaShares Australian Equities Strong Bear Hedge Fund [ASX:BBOZ].
I respect this outlook, but ultimately reject it.
Let’s start with the ‘cash problem’.
This superannuation guru said it
This is what Mark Delaney, the chief investment officer of AustralianSuper, recently said:
‘We don’t think the next 12 to 18 months is the time to preserve capital.’
And here’s a breakdown of AustralianSuper’s holdings:
‘The fund, Australia’s biggest, has about 58 per cent of its assets in listed equities, roughly 32 per cent in international equities and 25 per cent in local stocks, and the rest in a mix of infrastructure, fixed income, property and private equity.’
This isn’t just another ‘cash is trash’ article though, rather it’s an endorsement of diversification and preparation.
I’m of the view that putting all your eggs in the cash/BBOZ basket is a risky proposition that may paradoxically appeal to the risk-averse.
Cash’s value is eroding quickly due to central bankers’ high jinks and BBOZ should probably be used as a hedge as opposed to an out-and-out profit play.
The trick is to strike a balance between riding some of the market dynamics I outlined before while also being prepared to take action when the time comes.
You could have a bit in crypto, a bit in commodities stocks or ETFs, some in small-caps, some larger value plays, a few renewables stocks, and some spare ammo in the form of cash.
Anything but all cash.
So here’s an insight into what we’ve done over at Exponential Stock Investor.
Cashing up to go again and reviewing funding risks
In the past couple months, we’ve taken some good money off the table for subscribers.
We’ve exited a fintech which was facing a regulatory issue at a small loss, closed a position, and taken half profits on a range of stocks.
The half profits are in the range of 80–196%.
This extra capital not only allows investors to enter new positions, it also gives peace of mind if the market starts to wobble further.
Meanwhile in the background, I’m completing a rigorous review of the cash positions of all the stocks in our portfolio.
Everyone knows in a crash, funding risk for small-caps becomes agenda issue #1.
That is, if a crash were to play out, companies with limited reserves may not survive or will be forced into taking extra capital on at onerous terms.
This is doing, not thinking.
You can do this with your own portfolio, it’s a valuable exercise.
Have a look at recent quarterlies and do a quick cash-to-market-cap ratio in your head.
One of the companies we closed a position on, had an eye-watering cash-to-market-cap ratio of about 40.
Meaning its market cap was about 40 times larger than its cash position.
In a crash, this kind of stock could come down hard, or even go insolvent.
A sobering thought.
Not many people use the cash-to-market-cap ratio, but it’s a good barometer for certain small-caps.
It gives you a sense of how stretched it is, and whether it could run into trouble down the track.
Whatever you do, don’t get caught in analysis paralysis.
Stay nimble, keep an eye on those cash positions, and above all, act when the time comes.
For Money Morning
PS: Lachlann is also the Editorial Analyst at Exponential Stock Investor, a stock tipping newsletter that hunts for promising small-cap stocks. For information on how to subscribe and see what Lachy’s telling subscribers right now, please click here.