Beware Of The ‘Cash On The Sidelines’ Ruse

It is an off-the-cuff remark that goes unchecked far too often.

“Record amounts of cash are on the sidelines still waiting to get back into this market and will push it even higher.”

I heard this statement during the market peak in 2007 and throughout the financial crisis. And, I’m still hearing it frequently today throughout the post-crisis period. Find an on-the-spot analyst in search of a reason why stock prices will go higher, and often they will go to the “record amounts of cash on the sidelines” well to support their argument. Unfortunately, the notion of cash on the sidelines supporting higher future stock prices quickly falls apart under closer examination.

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Why Cash Is King

The investment world is a place where sensible thinking can sometimes get completely turned upside down. This is absolutely true when it comes to holding cash. For the conventional wisdom among most investors is that you must be fully invested at all times. But in reality, this stubborn thinking defies rationale in many ways. Cash is king for a reason, and this holds true when it comes to investing in capital markets.

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The Good News From A Bad Friday

Friday was another down day for stocks following the notable -2% decline on Thursday. After a few feeble pushes to the upside in the early morning trade, stocks rolled over and were solidly down once again by midday before battling back into the close. But despite the generally poor performance of stocks for a second consecutive day on Friday, several important points of good news accompanied the bad. Overall, investors could find reassurance at least as we head into the weekend that the latest stock market correction is taking on a more orderly behavior.

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Why Thursday’s Sell-Off Matters

The stock market was rocked on Thursday, posting its worst single day decline in nearly four months. Such declines are certainly not unexpected, and it was clear following a spring and summer of quiet markets that some degree of downside volatility was more than overdue. But unlike many other recent stock market pullbacks, Thursday’s decline was notable, as it came with a convergence of troubling forces not seen in capital markets in over a year. In short, the stock market sell-off on Thursday matters, and how events unfold in the coming days should be watched closely for potential action, if needed.

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Less Than Zero: The Case For Cash

Investors receive virtually no direct reward for holding cash in the current market environment. Thanks to the Fed’s zero interest rate policy that has been in place since December 2008, the interest earned for holding cash has fallen to effectively nothing even on the largest of balances. And with the stock market soaring to record highs in recent years during a time when annualized inflation has been running anywhere between +1% to +4%, the opportunity cost associated with holding cash has been dear to say the least. But despite all of these challenges, the case for holding cash may be growing stronger with each and every point that is added to the S&P 500 Index.

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