Is It Finally Time To Cash In?

Is It Finally Time To Cash In?
Stéphane Renevier, CFA

about 2 years ago4 mins

  • There are a couple of reasons not to cash in your stock market investments yet, namely the robustness of the recovery and the fact that you don’t really have any better options.

  • But there are plenty of reasons to bite the bullet, from stretched valuations, macro headwinds, no more Fed support, and a difficult end of year.

  • So it could well be time to take some of your gains so you have more cash for when genuinely exciting opportunities emerge.

There are a couple of reasons not to cash in your stock market investments yet, namely the robustness of the recovery and the fact that you don’t really have any better options.

But there are plenty of reasons to bite the bullet, from stretched valuations, macro headwinds, no more Fed support, and a difficult end of year.

So it could well be time to take some of your gains so you have more cash for when genuinely exciting opportunities emerge.

Mentioned in story

The Omicron variant is threatening to tip the stock market rally off balance, and investors far and wide are securing their profits in case this golden period is coming to an end. So let’s look at whether you should be doing the same…

Why shouldn’t you cash in yet?

The recovery is actually quite robust. Profit margins have held surprisingly steady and earnings growth has remained strong despite heightened inflationary pressures. Omicron aside, the economy should continue to benefit from a boost in spending as people use up their pent-up savings. And if supply pressures ease and supply can finally match demand, the economy could quickly go back to its winning ways.

There’s not exactly much alternative. With bond yields so low, investors are being forced to take some risks if they want to generate returns. And as long as inflation doesn’t get out of control, stocks remain one of the surest ways of generating high returns over the long term. Sure, private markets and real assets have become an increasingly attractive option, but they’re difficult to access and their illiquidity makes them unfit for many investors.

Why should you cash in?

Investors are fighting macro headwinds. The macro environment continues to worsen for stocks, with markets now facing the threat of a serious slowdown in growth accompanied by stubbornly high inflation. Slower economic growth would negatively impact companies’ revenue growth, while persistently high inflation could shrink their margins and lead to a higher discount rate. And since investors traditionally discount future cash flows to estimate a company’s current value, lower future cash flows discounted at a higher rate would mean lower stock prices.

The Fed put is gone. Since the global financial crisis, investors have got used to the Federal Reserve (the Fed) rescuing markets at the first sign of trouble. The existence of this “Fed put” has been a huge supporting factor in the current bull market, giving investors the confidence that the Fed would not let a market crash happen. But that’s different now, as inflationary pressures are making it unlikely that the Fed would cut rates if things turn sour. Fed chair Jerome Powell confirmed as much this week: he acknowledged that inflation is more persistent than expected, and signaled that the Fed could wind up its asset purchases faster than expected to slow inflation down. The removal of the Fed put would make buying the dip a much more risky proposition, and could turn a small correction into a more significant crash.

Valuations are stretched. Investors might disagree about just how stretched valuations are, but it’s hard to argue that they aren’t stretched. In fact, they’re a lot higher than they were in March 2020 before the first Covid wave hit. And signs of euphoria – generally the last stage of a bull market – are also more present this time around. That matters because changes in valuations are an important driver of stock returns, and the currently elevated levels are making further gains very unlikely. Without the support of valuations, all the pressure is on earnings growth – and if that’s peaked too, things could turn ugly real fast.

December could prove a tricky month. First, there are plenty of important meetings that could easily go sour, including the deadline for the US government to raise the debt ceiling and the Fed policy meeting on December 15th. Flows from fund managers could also push markets lower: portfolio managers typically sell their losers in December to harvest tax benefits, as well as to save face when disclosing their year-end holdings (it never looks good to own stinkers in your portfolio come the new year). And last but not least, investors that have had a good year will also be reluctant to take on more risk, which could lead to some “sell first, ask later” behavior.

So... should you cash in?

Successful investing is all about assessing the risks and rewards of an investment. And right now, investors are arguably pretty relaxed about the potential risks despite a clear deterioration of the investing environment. And while stocks might grind a few percent higher, their downside appears particularly large at a time when things could turn on a dime. In other words, the potential rewards for holding stocks don’t compensate you well enough for the potential risks.

So yes, it could certainly be a great opportunity to take some of your profits, which are purely theoretical until you actually close your trades. As for how much you cash in, that’ll depend on you: your objectives, your market views, and your constraints. But however much you end up freeing up, it’ll mean you have some extra cash to hand as dry powder for when risk/reward dynamics are interesting once again. Just like Warren Buffett said: “Be fearful when others are greedy and greedy when others are fearful.”

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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