Over the last few months the markets have reacted violently to the good news about quantitative easing being tapered or stopped by dropping significantly, only to then increase significantly when bad news provides the rationale for QE not to be turned off at all!
The thing that should really surprise us all with this talk of good and bad news is…
… no one is talking about the next potential correction in the markets. Look at the US market - it reached its all time high in the first week of November; the FTSE is up 22% over the past year and 60% over the past five years! Both are just about to or have surpassed the 2008 highs.
The other interesting thing about the past five years is that no one has come up with a solution for cash – in fact investment managers steered clear of it because of the limitations on what they could do with it. The result of all of this is that over the past two years cash has been pumped into the equity markets, resulting in the increases that we have seen.
Perhaps it is time to start increasing cash in the event of the next market downturn? Some may say that the downturn won’t happen for some time, therefore make hay whilst the sun shines! Wasn’t that what was said in 2007 before the crash of 2008? (Interesting that some investment managers are now talking about cash solutions).
With markets so high, our view is that organisations should now be considering how much cash they need from their investments over the next two to three years. This may be a combination of income and realisation on investments. Why? So that these funds are now accumulated and put into their so-called “cookie jar” for the rainy day which will inevitably happen. (According to Goldman Sachs this downturn will take place within the next eight years - when is anyone’s guess!)
Once the cookie jar is established it allows an organisation to weather the storm by not having to drawn on investments or rely solely on the potentially lower income streams likely to occur at the same time.
Some will of course say that establishing a cookie jar will cause real value to decline relative to inflation, however when the markets drop inflation is likely to increase rapidly, and keeping up with it will be difficult anyway! In the intervening period giving up a little real value for the certainty definitely makes our clients sleep better at night.
And, if markets take off some will be tempted to raid the cookie jar like Cookie Monster, trying to improve the overall return. The result will all too often be a feeling of immediate satisfaction, followed by that sinking feeling on returning to the cookie jar only to find it empty!