The S&P/ASX 200 (INDEXASX: XJO) index is trading close to an 11-year high as investors are feeling more optimistic about the economy following the federal election and growing expectations of interest rate cuts by the Reserve Bank of Australia.
You might think lower rates and higher risk appetite would drive most investors away from holding cash. You’re probably right, but I’ve gone overweight on cash as I’ve been actively selling shares into the recent rally.
It might sound like a controversial call, but I think now is the time to be collecting cash so that investors can better capitalise on select opportunities in the next market correction.
Trying to time the market is always a mug’s game and it’s rare to find me going overweight on cash, let alone by such a wide margin, but my decision to go 35% cash (that’s a lot for me) is driven by two key factors.
The sharemarket is underestimating current risks
The first is my belief that the market is under-appreciating risks, after the ASX 200 surged 14% since the start of calendar 2019. That’s roughly what I would hope the market would deliver in a full year, and we aren’t even in June yet.
The cheers from talk of aggressive rate cuts are also worrying me. I love rate cuts as much as the next ASX investor, but I will admit I feel a little disconcerted this time. It seems every time economists talk about rate cuts, they are expecting more.
It was only a few months ago we were half expecting one cut and now we have largely priced in three. JP Morgan has gone a step further to forecast four cuts, which would bring our interest rate down to just 0.5%.
Rates only go that close to zero during an emergency, and you can’t detect any sense of worry from equity investors. It seems bond market and equity market investors have very different outlooks!
The yield inversion in the US between the three-month and 10-year treasury bond has gotten worse too, and that’s historically been a good predictor of a looming recession. It’s times like these that Warren Buffett’s teachings about being fearful when others are greedy should come to mind.
The risk–reward balance
The other factor that has prompted me to hoard cash is the risk–reward balance. The market may not pull back as I am expecting but keep running ahead. However, even if I have mistimed the exit, I don’t think I’ve left too much money on the table as the fundamentals do not support our market rallying much higher from here, even if the economy holds together better than most expect.
On the flipside, if my shorter-term downbeat view is right, it can end up costing me more than what I stand to gain by staying fully invested in the market. Having some liquidity to capitalise on opportunities in a market downturn is always a good idea. I can only hope when we get a market sell-off, that the drop won’t last more than a couple of months at worst.
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The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.