Friday, March 30, 2012

America: a Nation of Cash Hoarders

The stock market has just finished its best quarter since 1998, with the S&P 500 up almost 12%. But retail investors keep exiting the market, stashing money in bonds or sidelining it in bank accounts and money market funds. Why are investors so skittish when returns seem so good? Because they've learned the hard way.

First, stock market gains are no longer seen as solid. That was the lesson of the 2000 tech market crash and the 2007-08 financial crisis. The lesson was reinforced by the May 2010 flash crash, and by the motion sickness caused by volatility from the European sovereign debt crisis. For Baby Boomers in particular, who are reaching retirement age, easing back on stocks and into more stable investments is eminently sensible. (For more on this point, see After all, it's pretty hard to retire on ethereal gains.

Second, financial assets derive much, if not most, of their value today from government policies and political maneuvering. Indeed, the world's second most important currency--the Euro--was created and is sustained by government policy and bailouts. Take the EU's governments out of the picture and there would be no Euro. Nothing is as unpredictable or unreliable as politics. And few investors want to bet their remaining retirement savings on the flightiness of politics.

Third, investors need only look at the smart money to see that cash is the preferred asset. Large corporations are hoarding cash like it was spring water in the Sahara. This cash hoarding reflects the breakdown of the banking system, which corporations in the U.S. and Europe know can't be relied upon. If big names in the corporate world are stuffing their mattresses with greenbacks, how many retail investors think they're so much smarter than major corporations that they should do something different? Okay, so Apple just declared a dividend. But that looks more like Apple is trying to prevent its cash hoard from getting larger rather than sending a lot of its current holdings of cash to shareholders.

Fourth, look at the banking system itself. Major banks borrow heavily from the Fed or the European Central Bank, only to turn it around and redeposit the borrowed funds with their central bank. Why? Because they're hoarding cash as well. They don't want to do something dangerous like invest in risk assets because they might lose money. Are investors to believe that risk assets are for them when the world's largest banks won't touch the cr . . . stuff.

Fifth, the Fed's longstanding suppression of positive interest rates net of inflation can only be viewed as an official statement that the economy is still deep in the septic tank and going nowhere fast. Its promise to stamp out positive interest rates until at least 2014 is tantamount to predicting that things won't get better any time soon. Who would want to invest in risk assets with the government so gloomy? When interest rates are effectively zero or less, you know you can't recover your losses from interest income. So it may be best not to take losses even if you get no gains. The Fed's blatant effort to arm twist investors into risk assets only pushes many of them away from taking any risk at all.

As regards economic recovery, we're basically in a stand off. Corporations aren't investing or hiring until consumer spending rebounds. But consumers won't spend because they're afraid of losing their jobs or have lost their jobs, and, for many, are underwater on their mortgages. The Federal Reserve's war on positive interest rates prevents savers from getting hardly a thimbleful of interest income. So retirees and others having savings dial back their consumption in order to preserve capital. The housing market remains a disaster area, with vast amounts of foreclosed properties and defaulted mortgages continuing to lurk. The losses in real estate (realized and unrealized) are so great that it will be years before this market recovers (for this writer's not inaccurate prediction made four and a half years ago, see

The biggest and most successful corporations hoard cash. The banks at the center of the financial system hoard cash. Cash feels good. (See Why wouldn't investors get on the bandwagon and hoard cash?

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