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Should you hoard cash like Warren Buffett and the private equity players?

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“I hate cash,” Warren Buffett said in an interview to CNBC, back in May of this year. However, by the end of second quarter, Berkshire Hathaway Inc., a company run by him for over five decades had $100 billion in cash and cash equivalents because Buffett is unable to find the right valuation to buy.

Key observations

  1. Warren Buffett is sitting on $100 billion of cash, waiting for the right opportunity to invest
  2. Private equity managers are holding about $963 billion in dry powder
  3. The S&P 500 is overvalued compared to historical numbers
  4. The US Fed’s tightening cycle and shrinking of balance sheet can lead to a recession
  5. How should investors approach the current markets

Similarly, private equity managers are sitting with record $963.3 billion in cash, according to researcher Preqin Ltd, reports Bloomberg. Are these warning signs of stocks being overvalued or is it a sign that there is enough money waiting on the sidelines to enter on every small dip, therefore, the investors should not expect a large correction in the near future.

What should the investor do? Raise the cash percentage in his portfolio and earn a paltry 1-2% return on it or stay in the market and ride the rally with a higher risk of a pullback? Let’s see.

Valuations are rich

Availability of easy money, buoyed by the accommodative monetary policy of the various central banks across the developed nations has boosted stock prices to lofty levels.

Source: multpl.com

At the current levels, the S&P 500 is quoting at a PE ratio of 24.69, which is way above the mean ratio of 15.67. Does this mean that the markets will crash tomorrow?

No! However, it shows that the risk of a downside is high because traders are paying high valuations to own shares of their favorite companies. If for some reason, the companies are unable to meet expectations, a fall is likely.

Similarly, another popular metric to measure the valuation of the index is the Shiller PE ratio, developed by Robert J. Shiller, the Nobel Laureate, economist, academic, best-selling author, and Sterling Professor of Economics at Yale University.

Source: multpl.com

The Shiller PE ratio is quoting at 30.31, a level which has been exceeded only during the dotcom bubble and we all know what happened when the bubble burst.

However, the critics point out that even at the lows of 2009, the Shiller PE ratio was about 15, just below the mean of 16.78. If traders had waited for lower levels, they would have missed the greatest opportunity of their lifetimes because the S&P 500 has risen more than 270% in the past eight years. Therefore, their argument is that when a system did not signal a bottom correctly, why follow it when it’s signaling a top?

They have a point. However, we have to keep in mind that most of the rally following the last financial crisis was the result of the Federal Reserve’s quantitative easing (QE) programs and zero interest rate policy (ZIRP).

Source: Zerohedge

The chart clearly shows the spikes in the S&P 500, as and when the Fed announced a QE. With a huge amount of liquidity squashing around, it is no surprise that a large percentage of it was invested into the equity markets, which led to the massive rise. Therefore, it is not fair to blame the Shiller PE ratio entirely.

But why has the stock market not fallen off the cliff, since the Fed stopped its QE measures and started hiking rates?

The Fed first hiked rates in December 2015 and thereafter waited for another year before raising rates again. In between, they were quick to come to the market’s rescue on every correction.

The Fed has become increasingly hawkish and has accelerated its pace of rate hikes only after the Presidential elections in November 2016. In 2017, it has already hiked rates twice and is likely to hike once again before the end of the year.

Furthermore, it is also likely to start shrinking its massive balance sheet soon. History shows that five out of the past six times the Fed has done that, the economy has faced a recession. Similarly, 10 out of 13 previous tightening cycles have led to a recession.

Wow. That’s a double whammy. Therefore, it will be prudent to expect a recession sooner than later. We have covered this topic in greater detail in our earlier article, “Will the Fed’s actions push the US into a recession”.

So, should the investor stay out of the equity markets completely?

No, because, no one knows when the current bull trend will end. Calling a top in a strongly trending market is next to impossible. Even Warren Buffett has not sold his core holdings because the market is overvalued. It is just that he has not done any fresh investments in the markets.

Due to the size of his investments, Buffett’s avenues are limited. However, as small investors, we have no such limitation.

The three ways an investor should approach the stock markets

If you stay out of a bubble completely, you can lose an opportunity to profit from the vertical rally just before the bubble bursts. Therefore, we recommend trading in stocks that are in momentum with an attractive risk/reward ratio. As these are momentum plays, traders should maintain strict discipline and respect their stop loss. However, due to the risks involved, the allocation size should be less than half of normal.

The second way to invest money during a bubble is to do it smartly. Due to the herd mentality among traders, most chase the sectors that are offering strong returns, thereby neglecting the underperformers.

At times, these beaten down stocks become dirt cheap and can be purchased for the long-term with minimal downside risk. However, investors should look closely at the company’s fundamentals before choosing a stock that is out of favor, because every underperforming stock is not a buying opportunity.

The third way is to wait for a confirmation of a market top and thereafter short the vulnerable sectors and stocks. Nevertheless, shorts should be initiated only after the markets turn decidedly bearish. Here too, the traders will have to maintain a strict discipline because short selling without an appropriate stop loss is a recipe for disaster.

So, shouldn’t you keep any cash at all?

As the market is not offering many opportunities, it is a good idea to keep about 30% to 40% of your portfolio in cash in the current market conditions because a correction of more than 10% will offer many opportunities to the astute investor to buy stocks at attractive valuations.

It’s apt to end with a Warren Buffett quote: “I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.”

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.7 stars on average, based on 9 rated postsRakesh Upadhyay is a Technical Analyst and Portfolio Consultant for The Summit Group. He has more than a decade of experience as a private trader. His philosophy is to use technical analysis for momentum trading and fundamental analysis for long-term positions. Rakesh likes to keep himself fit by lifting weights and considers himself to be a spiritual person.




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6 Comments

6 Comments

  1. embersburnbrightly

    September 3, 2017 at 12:21 pm

    Excellent article!

    • Rakesh Upadhyay

      September 4, 2017 at 8:07 am

      Hello embersburnbrightly,

      Thank you. I am glad you liked it.

  2. hoodun

    September 3, 2017 at 10:16 pm

    Tether is my cash.

    • Rakesh Upadhyay

      September 4, 2017 at 8:12 am

      Hello hoodun,

      If you plan to park your cash in an asset, technically, that is again an investment, which carries a certain amount of risk. Therefore, it is not similar to holding cash.

  3. bens

    September 12, 2017 at 8:49 pm

    “The second way to invest money during a bubble is to do it smartly. Due to the herd mentality among traders, most chase the sectors that are offering strong returns, thereby neglecting the underperformers.

    At times, these beaten down stocks become dirt cheap and can be purchased for the long-term with minimal downside risk. However, investors should look closely at the company’s fundamentals before choosing a stock that is out of favor, because every underperforming stock is not a buying opportunity.”

    =============== Can you give an example of an under performer that fits the criteria in which you are referring to? ==============

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Analysis

GBP/USD Price Prediction: Cable Could be Hit Harder This Week

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  • Big fundamental data points will play a massive role in the direction of GBP this week.
  • GBP/USD downside targets are eyed at 1.2800 and then the range of 1.2750-1.2650.

It is another week where GBP takes the spotlight with a raft of key economic data points being released from the UK. This comes after an extremely volatile week where GBP/USD finished another close in the red. In an already delicate time for the UK and its domestic currency, given the Brexit palaver, this slew of key fundamental data is only going to see volatility rising.

Recap Last Week

Cable last week came under quite a large amount of selling pressure, which was initially kicked off due to weaker PMI data. Britain had produced soft construction and services PMI data, which triggered the bears to get into action. Furthermore, the Bank of England released their monetary policy decision, where they left rates unchanged; however, officials were very much dovish. They slashed their growth forecasts, citing Brexit damages. GBP managed to reverse this initial spike to the downside, after Carney essentially hinted rate rises could still come. The market read between the lines following his comment: “There is upside for UK economy if there is clarity on Brexit deal sooner”.

Critical Data Points This Week

On Monday, UK will release its GDP figures, which are expected to cool across the board. This is not too much of a surprise, given lacklustre economic data points that have been released already this year, including falling retail sales and a drop-in consumer confidence to around weakest levels in more than fives years. PMI sectors are close to recession and most recently the BOE downgraded its growth forecasts. Elsewhere, later in the week, eyes will also be on the retail sales and CPI numbers, both of which are expected to cool. Should all above-detailed data come in soft, then expect further selling pressure to continue for GBP this week.

Technical Review – GBP/USD

GBP/USD weekly chart.

The weekly chart view remains firmly bearish, following on from the last two consecutive weeks of losses. In terms of the daily, price action is currently trying to break down near-term demand. This can be observed between 1.3000 down to around 1.2915. Should the bears manage to convincingly break and close below, then eyes will be on a retest of 1.2800 to the downside. GBP/USD last traded down there on 17th January. Further downside targets would be the 1.2750-1.2650 range, where the next major area of demand can be seen. Shorts would likely be off the cards near-term if the price manages to break and close back above the psychological 1.3000 mark.

GBP/USD daily chart.

In terms of direction this week, it is very much going to be dictated by the above-listed key economic data points. The bears will likely capitalize on the described downside targets, only if the numbers disappoint market participants.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.6 stars on average, based on 124 rated postsKen has over 8 years exposure to the financial markets. During a large part of his career, he worked as an analyst, covering a variety of asset classes; forex, fixed income, commodities, equities and cryptocurrencies. Ken has gone on to become a regular contributor across several large news and analysis outlets.




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Bitcoin

Davos: What’s Bitcoin’s Role in Trump and China’s ‘New World Order’?

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According to Investec CEO Hendrik du Toit, despite U.S, President Donald Trump and China’s President Xi Jinping not coming face to face at Davos this week, the event is still encapsulated by their simmering economic battle.

The chief of the global investment firm suggested that Davos represents a thrashing out of the coming ‘new world order’ – with the U.S. and China fighting for a seat at the head of the table.

Amid these talks some still found time to throw FUD on Bitcoin and cryptocurrency in general. But putting aside price predictions for the moment, just what is crypto’s role in this new world order? The answer probably has nothing to do with its role as a digital currency.

New World Order at Davos

Du Toit told was quoted as telling CNBC reporters on Thursday morning that:

“The big uncertainty is the U.S.-China trade negotiation which is not really about trade, it’s about a new world order.”

Henrik also made allusions to China’s recent slump in GDP growth, which just hit the thirty year low of 6.6%. As many former communist nations have discovered in the past thirty years, it’s easier to record growth when you don’t have much to begin with. Now China is up in the big leagues, and it’s not entirely clear how the country will adapt to its new surroundings. Du Toit continued:

“And if we get a dysfunctional world order having come from a space which was very, very good business over the last 20, 30 years since communism fell, then there may be some big hits along the way and there may be some big challenges.”

Keeping Score

China’s GDP growth rate is still almost three times that of the U.S, and the trade deficit between the two nations saw China record a $350 billion surplus at the end of the year in 2018. Exports to the U.S. rose 11.3% last year, compared to the measly 0.7% increase in U.S. goods shipped to China.

However, few statistics tell the whole story, and according to financial analyst Gary Shilling, the trade deficit is a clear sign of American dominance, as he recently posited:

“The thing is…we (the U.S) are the buyer, and they’re the seller – and when you’ve got plenty of goods and services, it’s the buyer who has the upper hand. And besides, where would China sell all this stuff if it wasn’t to American consumers?”

Shilling went so far as to say that Donald Trump currently has the upper hand in the trade war, and that U.S. economic dominance would continue to eclipse China – specifically due to Trump’s ‘America first’ policies.

“I think ultimately we’re going to see more imports of American goods into China; they are going to be less aggressive on exports; they’re going to steal less technology, they’re going to demand less technology for the cost of doing business in China. I think it’s going to shift in America’s favour, but the transition is rough.”

Weaponizing Bitcoin

Shilling’s take encapsulates a best-case scenario – one where the growing number of Chinese troops terraforming the South China sea, and the constant theft of U.S-patented technologies don’t cause global tensions to boil over.

But if they did boil over there’s every reason to assume that cryptocurrency, and Bitcoin in particular, would have a major role to play. However, that role may be its last on the world stage.

Estimates towards the end of 2018 placed over 80% of Bitcoin’s mining power in China. Given the Chinese government’s tendency to simply take things they like, any conflict between them and the U.S. would likely see Bitcoin weaponized, and its ‘distributed’ ledger commandeered.

A recent Forbes article suggested as much, and claimed that China’s Bitcoin’s dominance posed a real threat to American tech, finance and economy. Furthermore, many nations have already taken steps to curb that dominance:

“While U.S. regulators are wrapped up in their own turf wars, other nations are moving fast to create a welcoming regulatory environment for cryptocurrency.”

That includes the U.K and the European Union, both of which have taken steps to increase the popularity of cryptocurrency and blockchain within their respective regions. It might terrify the banksters to see blockchain spread around the Western world, however, the shadowy figures at the levers of governmental control are already attempting to leverage blockchain technology in their favour.

Hash Wars

How much would it be worth to China and the U.S. to gain control over Bitcoin’s ledger? In the previous century we saw the world’s nations sacrifice not only money and resources, but also a majority of their male adult populations for a slice of whichever pie was being baked at the time.

While many major cryptocurrencies can be commandeered for just a few thousand dollars per hour, Bitcoin would cost $261,379 per hour to control according to independent data. The Ethereum Classic blockchain can currently be bought for $4,275 per hour via cloud-mining marketplaces like Nicehash, but control of BTC wouldn’t be sought in that way.

More likely both nations would get to work on building the largest mining farms they could, made up of as yet unseen super-computers from various R&D labs hidden around the country. A digital battle for control of Bitcoin would ultimately be decided by which nation could develop their computational tech the quickest.

America needs YOUR Bitcoin!

Such a scenario would see the sharpest minds in silicon valley employed as government agents in much the same scenario as mathematicians and codebreakers during the second world war. By the end, the Bitcoin blockchain would be illegitimate and abandoned; and the lasting legacy of BTC would be as a bit-part player in the much larger engagement that was World War 3.

Looking Ahead

Not all the noises coming out of Davos this week were so ominous. The CEO of Nasdaq, Adena Friedman, recently offered the possibility that cryptocurrency could still be the global currency of the future.

Meanwhile, Circle CEO, Jeremy Allaire, suggested that if humanity is to survive the digital age, it will require the resilient and decentralized tools which crypto and blockchain provide.

Disclaimer: The author owns bitcoin, Ethereum and other cryptocurrencies. He holds investment positions in the coins, but does not engage in short-term or day-trading.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.5 stars on average, based on 145 rated postsGreg Thomson is a full-time crypto writer and digital nomad. He eats ICOs for breakfast and bleeds altcoins. Wherever he lays his public key is his home.




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Analysis

GBP/JPY Price Prediction: Cable Jumps Over 150 Pips With Room for Another Squeeze Higher

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  • GBP/JPY saw decent gains on Wednesday, receiving a helping hand from Brexit and BOJ fundamentals.
  • Brexit optimism helps GBP higher, while BOJ remain dovish, adding pressure to JPY.

GBP/JPY jumped to its highest levels seen since 14th December 2018. The session high print was observed at 143.56, with the pair having gained over 150 pips. In terms of the reasoning, it was heavily attributed to fundamental factors, both for Britain and Japan.

Bank of Japan Dovish Tone

In the very early hours of European trading, the Bank of Japan (BOJ) released its monetary policy decision. As anticipated, the central bank maintained much of a dovish tone to its rhetoric. Policymakers slashed their inflation forecasts, while maintaining their huge stimulus programme. Governor Haruhiko Kuroda noted strong and growing risks to the economy, including trade protectionism and faltering global demand.

The BOJ added that, “Such downside risks concerning overseas economies are likely to be heightening recently, and it also is necessary to pay close attention to their impact on firms’ and households’ sentiment in Japan,”

As such, there were no changes made to monetary policy this time round. It is likely going to be a challenge for the Bank of Japan to discuss policy normalization or even an exit strategy for the moment, given as they themselves highlight that global economic risks are rising. This tone added to the broad JPY weakness observed across the board.

Renewed Brexit Optimism

The rally seen for GBP today was sparked following the Labour Party publicly saying they will back a postponement proposal. This essentially could hold off any decision on Brexit until the end of the year, extending Article 50. Elsewhere, the European Commission commented on the news wires, noting they will do their best to avoid a hard border in Ireland.

These fundamental developments were huge drivers in the aggressive move north for GBP/JPY. The Brexit news as detailed was supportive for the pound, whereas the BOJ commentary was largely digested as a JPY negative.

Technical Review – GBPJPY

GBP/JPY 1-hour chart.

Upside momentum looks set to maintain it course. With that in mind, it is worth knowing the next major barriers for the bulls. Looking via the daily chart view, the next area of resistance is not seen until 143.95. This was the 13th December high, which would be closely watched, as it could produce a double top formation. If the bulls have enough steam behind their run higher to breakthrough, then eyes will be on 145.50.

GBP/JPY daily chart.

In terms of the 60-minute chart view, price action is supported by an ascending hourly trend line. This has been running since the early hours of trading on 22nd January. A failure of this holding could see a drop back down to 142.20, hourly support. Further south, if selling pressure picks up pace, then a demand zone can be seen down at 140.80-50 range.

To conclude, the bias remains bullish near-term for a decent run up a the 13th December high area, 143.95. Longs may be off the cards if the hourly ascending trend line is breached, but this remains intact at the time of writing.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.6 stars on average, based on 124 rated postsKen has over 8 years exposure to the financial markets. During a large part of his career, he worked as an analyst, covering a variety of asset classes; forex, fixed income, commodities, equities and cryptocurrencies. Ken has gone on to become a regular contributor across several large news and analysis outlets.




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