July 16, 2001
Dow Jones Average: 10,539
S&P 500 Index: 1,216
The Value of Cash
In a world of rising prices for many goods and services the value
of cash in a money market fund is debatable. Medical costs, auto prices,
food, energy, housing, and college bills are all rising, eroding the
purchasing power of one's cash. In
countries beset by hyperinflation cash depreciates daily until it
is barely worth the paper it is written on. The devalued currency
is eventually replaced with newly denominated notes. Even in a lower
inflation country, such as the U.S., people have been conditioned
to think of cash as an asset that slowly loses purchasing power.
If inflation reduces the value of cash, it stands to
reason that deflation increases the value of cash holdings. While
it may be true that many things are more expensive, some are actually
becoming cheaper. Computers continue to drop in price as they have
for many years. By simply delaying a computer purchase for a few months
one can virtually guarantee that they will be able to buy a better,
faster machine for less money. The other major asset category currently
gripped by deflation is stocks. For the past eighteen months shares
of most stocks have been declining in price. After many years of upward
price action it has become clear that stocks are an asset class that
can deflate as well as inflate.
The value of cash has risen dramatically relative to
stock prices. Some eighteen months ago 16,000 dollars would have been
enough to buy a paltry 61 shares of Yahoo. Now that same 16,000 can
buy 1,000 shares, fifteen times as much, of the same company. One
year ago an investor needed 8,000 dollars to buy 100 shares of Cisco.
One can now buy 500 shares of Cisco for about 8,000 dollars. That
represents a 500 percent increase in the purchasing power of cash
relative to Cisco shares. We are not saying that Yahoo, Cisco, and
other stocks like them are great buys at this point. We mention them
simply to illustrate the increasing value of cash relative to stock
prices. The list goes on and on, in thousands of cases stocks have
deflated so much that anyone with a modest amount of cash can now
acquire a sizable share position. In the long run the size of one's
ownership stake in a company has everything to do with how much benefit
one derives from the
company's operations and success.
Holders of cash should be elated at their increased
purchasing power relative to stock prices. Imagine the public's reaction
if new car prices fell from 30,000 dollars per car to 10,000 dollars.
Everyone considering a new car purchase would be thrilled. We detect
no such enthusiasm among investors holding cash. They seem content,
a bit bored, but certainly not excited about the profound increase
in the purchasing power of their cash. The public treats hard assets
such as automobiles differently than paper assets such as stocks.
There is something about declining stock prices that depresses most
people and scares them away. While it is still early in our opinion
to begin aggressively buying stocks, the possibilities for buyers
are expanding.
Current Strategy
The consensus view among investors is that interest
rate cuts will lead to a prompt, vigorous recovery in the economy.
We are skeptical of this scenario, as we see no particular product
categories that will be driven by consumer demand. The country is
awash in computers, many sitting idle. After talking up a second half
recovery in tech, most analysts and technology companies admit that
their proclamations were premature. Other areas of the economy are
as saturated as tech. Auto and housing sales have been running at
strong levels. These all-important areas of the economy seem more
poised for a slowdown than a recovery. It is unlikely that U.S. companies
will be selling more products overseas as Japan, Singapore, Argentina,
and many other countries are mired in recession. We foresee a prolonged
period of sluggish sales and weak corporate profits.
Cash reserves and bonds are important strategic holdings
in unstable times. The current economic slowdown has been led by businesses
curtailing spending on technology products and new production facilities.
If the U.S. consumer, worried about layoffs and high personal debt
levels, starts to cut back on spending, the country will enter the
next stage of economic contraction. Given the economic risks it is
not surprising that cash has outperformed the typical stock by 30
percent over the past twelve months. Most people focus on the interest
rate their cash earns while only vaguely considering the purchasing
power of cash relative to other assets. In the long run the benefits
derived from purchasing cheap assets, such as depressed stocks, is
likely to outweigh the interest income earned on the cash. If the
economy, corporate profits, and stock prices continue to slump cash
will be an attractive alternative regardless of whether it yields
3 or 6 percent in current interest income.
Bonds offer a somewhat higher rate of return than cash,
but are not as flexible. The value of bonds changes daily based on
investor perceptions of economic strength and inflation. Although
one does recover full value when bonds mature, the temporary changes
in bond values can be costly if one is looking to sell the bonds before
maturity in order to buy stocks.
We do hold some stocks in our clients’ accounts
as there is an outside chance that the economy will gain strength
or at least be perceived as recovering. Stocks such as Nucor, Hubbell,
FedEx, and NY Times would be beneficiaries of a stronger economy.
These stocks are rising modestly as investors remain generally hopeful
about the economy. We are concerned that stocks are rising as operating
results deteriorate. The disparity between results and stock prices
is reminiscent of the technology companies trading on hope and speculation
in late 1999. A more muted version of speculative buying is now appearing
in the basic industry stocks. While some of our holdings are benefiting
from this latest trend we do not take much solace from these gains.
We would prefer to see the companies doing well as opposed to the
stock prices. Given the depth of the economic downturn it has become
increasingly difficult to find companies that can both weather the
storm and benefit from an eventual, economic upturn. Until we find
more quality companies at appealing prices we will keep a higher than
normal level of cash and bonds in our clients’ accounts.
