Market Timing

Cash and "market timing"

Is holding a large amount of cash an attempt to time the market?

For the active investor, engaged in selecting individual securities, I don’t think so.

The amount of cash in a portfolio is merely dependent on the opportunity set available. If there are no opportunities available, or if existing positions have appreciated beyond fair value and have been sold, then the cash position will naturally be higher.

Anything less than that seems like an abdication of an investing process that depends on intrinsic valuation.

To some, holding any amount of cash may seem like an attempt to “time the market.” But no macroeconomic forecast or opinion on the general level of the market is required. Each investment decision can be examined individually, and valued according to its own intrinsic merits and business prospects, at that particular point in time. The cash position will fall where it may.

To invert the question: if you don’t sell a security that you think is overvalued, then isn’t holding on to it a stronger form of market timing? Because then you are merely hoping that the general trend of the market will carry your holdings higher still, independent of your assessment of true worth.

Of course, you could be wrong in your assessment of an individual company, and what seems overvalued could prove to be cheap. And you could repeatedly make this error over a large set of securities for a long period of time. But this is a fundamentally different issue than attempting to time the market.

Many value investors also argue that if your holding period is “forever” then it doesn’t matter if your holdings are temporarily overvalued. But these same investors often complain that “growth” stocks are too expensive, because their cash flows are far off into the future, and the future is uncertain. So what gives them the confidence that their own holdings will fare any better in this same uncertain future, especially if the argument is that temporary overvaluation doesn’t matter in the “very long run”?

To be clear, I have no idea if holding large amounts of cash right now will prove beneficial. Historically, it has been a losing move. But I think there is a big difference between “holding a lot of cash because you think the general market is overvalued” and “holding a lot of cash because you can’t find enough individual attractive opportunities.” One is a direct market timing call, while the other is an indirect consequence of a seemingly rational investment process. While the end result might be similar, there are important differences in how you get there, and these differences (at least for me) define the line between speculation and investment.