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When Markets Crash, Cash is King

Aug 27, 2015

In this issue:
» Average size of Indian factories on a downtrend
» Realty slump takes toll on labour wages
» ...and more!


00:00

I had a chance encounter with an acquaintance the morning after the Monday market crash. The man, now in his fifties, made no pretence to hide his anxiety. The steep market fall had clearly jolted his confidence. He seemed concerned about what was happening in China...and whether we were about to witness another big financial crash like in 2008. So now, he was seeking reassurance from me.

I confessed to him that I wasn't an expert on China...or the global economy.

I even admitted that I had no clue how deep the market correction could go...or how quickly the markets would bounce back...

However, I pointed out that if the markets corrected further, these could be exciting times for value investors looking to scoop up good businesses at good prices.

To this, came an almost apologetic response, "But I am fully invested in stocks right now. I deployed all my surplus funds some months ago when the markets appeared to be in a tireless bull rally. I have hardly any cash left to buy stocks at the moment."

This gentleman had been a late entrant to the bull rally in the Indian stock markets. The allure of quick returns had made him greedy and impatient. The 'action itch' prompted him to deploy his investible surplus into stocks without caring much about valuations. He had no cash left to take advantage of a market crash. All he could see was the depreciated value of his stock portfolio.

The role of cash in the context of stock investing

Warren Buffet once said, "The one thing I will tell you is the worst investment you can have is cash. Everybody is talking about cash being king and all that sort of thing. Cash is going to become worth less over time. But good businesses are going to become worth more over time."

This makes perfect sense, doesn't it? Idle cash is unproductive.

How is it, then, that Berkshire Hathaway's cash file has been swelling over the years? At the end of December 2014, the conglomerate boasted of cash reserves worth US$63 billion! Is Buffett contradicting himself?

The answer is no. Holding cash in the absence of compelling investment opportunities makes complete sense. You aren't going to become rich simply by getting rid of cash and putting the money in stocks, regardless of valuations.

The cash hoard may appear bothersome on Berkshire Hathaway's balance sheet. But when the markets crash or when good investment opportunities arise, Buffett tends to be in the most enviable position to make big, solid bets at prices to his liking.

Here are some important investing lessons that I believe you should keep in mind during bull runs...

Never let greed or jealousy drive you to make hasty investment decisions.

If valuations are not convincingly attractive, then do not make big investments at one go. A balanced approach would be to stagger your investments over different market levels so you don't get trapped buying right at the market peak.

When markets appear too overoptimistic, reduce your exposure to stocks and keep some cash at hand.

When markets crash and valuations look attractive, use that cash to make some solid long term investments.

Do you think it is wise to set aside some cash to take advantage of market crashes? Let us know your comments or share your views in the Equitymaster Club.

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02:40
 Chart of the day
You look at what industrial India was in 1980, and what it is now, and you'd think that the country has indeed come a long way. You'd think that industries in India have become savvier, larger in size, and more competitive. But you'd be wrong, at least, on one of these counts.

A recent Livemint report highlights this very counterintuitive trend. Data on organized manufacturing employment from the Annual Survey of Industries indicates that large factories employing more than 1,000 workers now employ a significantly smaller share of the organized workforce in the country then they did in 1980. In fact, their share has fallen a full 16 percentage points - from about 45% 3 decades back to about 28.5% now. Consequently, the average number of workers per factory has also fallen quite significantly from about 65 in 1970 to just about 45 in 2013.

There could be some other influences at play here, including growing mechanization. However, to the extent that this data is actually a reflection of the falling size of the average industrial factory in India, this is a worrying sign indeed. For if 'Make in India' has to be a success, and India has to become an industrial powerhouse, its costs have to look competitive when compared on a global stage. And having large factories and the consequent economies of scale would be an important ingredient for this.

Declining size of factories in India?

03:50
While we seriously hope that the intensifying slowdown in India's real estate sector has the positive effect of a cooling off in housing prices, it is also having some negative effects. The decade long boom in construction in upcoming cities like Noida had created millions of jobs for labourers from across the country. A Reuters report indicates that this could be as high as 1 in every 3 new jobs. However, the downturn in the sector is now creating a scenario where this process is now going into reverse.

A large inventory of unsold homes is causing debt burdened real estate companies to downsize its workforce as they slow down work on existing projects and put-off new projects. The collateral effect of all this is now being felt in places such Bihar, which has been a big source of labourers. In fact, the aforementioned report goes on to indicate that with the paucity of jobs in the construction markets, rural wages may now actually be falling. And this comes in the backdrop of double digit rises in wages over the last few years. If the economy and consumer demand has to pick up in any meaningful manner, job creation in other sectors is indeed the need of the hour.

Publisher's Note: Vivek Kaul, the India Editor of the Daily Reckoning, just made a bold call - Real Estate priced are headed for a fall. Well, if you are someone who is looking to buy real estate, or is just interested in the space, I recommend you read Vivek's detailed views in his just published report "The (In)Complete Guide To Real Estate". To claim your copy of this Free Report, please click here...

04:45
The Indian stock markets were trading strong today on the back of sustained buying activity across most index heavyweights. At the time of writing, the BSE-Sensex was trading up by around 510 points. The biggest gains were seen in energy and realty stocks.

04:55
 Today's investing mantra
"If the market were way over priced, I wouldn't own any stocks" - Walter Schloss

This edition of The 5 Minute WrapUp is authored by Ankit Shah (Research Analyst).

Today's Premium Edition.

Stocks with high promoter pledging to be hit harder

Stocks with high promoter pledging are likely to get hit hardest in a market crash.
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3 Responses to "When Markets Crash, Cash is King"

Rakesh Chandra

Aug 27, 2015

In my view main cause of lesser workers in factories is more advanced automated machines requiring less workers.New trends is to use robotic factories.Only few days back China has launched fully robotic factory with no labour.Only few supervisors on computers will check on each robotic production line that all is ok.Even in IT industries now automated computers are now going to replace software professionals of lower and mid cadre.

Like (1)

Rakesh Chandra

Aug 27, 2015

Yes i agree,cash is king for such falls.In bull times one should gradually book profits to keep at least 5%of portfolio value as cash.If one is out off cash he can balance his portfolio by exiting weak stocks as during fall good and bad all stocks have corrected almost equally.Please comment.

Like (1)

foo

Aug 27, 2015

What an amazing headline. I never knew this!

Like (1)
  
Equitymaster requests your view! Post a comment on "When Markets Crash, Cash is King". Click here!
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