Saving cash for a rainy day!

The wave of mergers and acquisitions around the globe fuelled by bullish optimism about the business outlook ought to provide a sense of deja-vu to older figures in the investment community. In the past such surges of optimism have usually preceded big capital market downturns.

The same can be said of stock markets hitting five-year highs in the West. Bull market cycles seldom last longer than five years, and this could be taken as a warning rather than a signal to pile in to drive stocks a little higher. Surely if nothing else the downside risk is much bigger than the upside potential which ought to be a black mark.

It is the same story in global real estate where rental returns are at record lows, and capital values look massively inflated by years of low interest rates which have just started to go up. Where is the value in investing in such a market where both capital values and rental income are likely to come under pressure from rising interest rates?

Assets expensive

Indeed, authorities as diverse as 'The Economist' magazine and AME Info commentator Dr. Marc Faber have been warning recently that all asset classes have risen too high in value and are due for a correction. 'The Economist' puts the choices on offer to achieve the correction as either: inflation or asset price falls.

This is a very perplexing scenario for investors, as inflation and deflation require opposite investment strategies. Dr. Marc Faber helpfully points out that in the 1930s gold prices rose despite deflation and would also rise in an inflationary climate, but then notes how gold collapsed in price in the mid-1970s before its historic high in 1980.

Going into cash also has its risks, notably devaluation particularly for the US dollar whose massive imbalances suggest devaluation is likely. Inflation too would erode the value of money, although interest rates would soar to at least partly compensate for this loss.

Dollar to rise?

However, if there was a massive sell-off of assets around the world, with some kind of a domino-effect with one market falling after another like the Arab stock markets of recent weeks, then this would produce a massive demand for US dollars as a safe haven currency, and the value of the dollar might actually rise substantially. And in truth who has not noted that the US dollar seems undervalued and not overvalued when traveling.

In any case, if capital markets correct then the old saying: 'In a recession cash is king!' comes to mind. For as market prices tumble this is precisely the time that you are likely to find the best investments - but you will need to have the cash to pay for them as credit is likely to be hard to come by.

Perhaps the prudent investor should therefore expand his or her cash position in the current booming markets, and prepare for a downturn, just as Arab stock bulls of a month ago must now wish that they had done.