The Once and Future King

This asset is the ultimate contrarian play. Nobody in the entire country wants to hold it, yet it’s such a prudent investment. And from tomorrow, the government will pay you 25% more money for holding it…probably.


What’s the most undervalued investment right now?

What’s the one asset you wouldn’t even think of holding?

I’ll give you a hint: According to the Investment Company Institute of America, this asset represented 77.1% of all mutual fund assets in 1981…

Gold was popular back then. But if you said gold, you’re wrong. Like gold, people buy this asset when they’re scared, like they were in 1981.

In 1999, this unloved asset fell to an all-time low of 23.7% of all mutual fund assets. Investors hold as little as possible of it when they’re very optimistic, like they were in 1999.

Today, 27.7% of all mutual fund assets are in this safe, liquid instrument. In historical terms, that seems pretty optimistic.

Perhaps by now you’ve guessed that the answer to these questions, the most unwanted asset today, the one thing nobody seems to want to own, the one asset people can’t seem to get rid of fast enough, is…

Cash Holdings: Large Cash Positions

Cash. The statistics I quoted above are the amount of total mutual fund assets invested in money market funds – funds that invest all their customers’ money in the most liquid short-term securities, like 13-week T-bills, which is how corporations and large investors hold cash.

I’m about to tell you that you should be holding plenty of cash, and I can explain it in, what I believe to be, the most compelling of terms…

The simple explanation is that every investor who really knows what he’s doing is holding a large cash position right now. By "every investor who really knows what he’s doing," I’m referring to some of the greatest investment minds of our time. Warren Buffett, Staley Cates & Mason Hawkins, Jim Gipson, Tweedy Browne, the Sequoia Fund and Alan van den Berg.

Warren Buffett has made more money investing than anyone else on the planet. According to his most recent balance sheet, Buffett is holding $34.68 billion in cash. That’s equal to about 25% of the $138 billion market cap of his Berkshire Hathaway empire. Berkshire Hathaway stock is selling for around $89,750 per share, and he’s holding $22,521 per share in cash. Subtract the cash, and Berkshire Hathaway is selling for slightly under 13 times GAAP earnings. Not quite Extreme Value material, but it’s interesting that the market thinks the greatest investor of all time isn’t worth as much as the S&P 500, at about 16.4 times GAAP earnings (and almost certainly a higher multiple of earnings reality).

Staley Cates and Mason Hawkins are the co-managers of the Longleaf Partners Fund, which we added to the Extreme Value portfolio in February. Longleaf Partners Fund’s cash position is now at about 25% of assets. I asked Staley Cates about this. The exchange went as follows:

Ferris: What on earth do you do when there’s nothing to buy? Do you just sit and wait? All the value investors are holding lots of cash.

Cates: Yes, we just sit and wait. That’s often very hard to do, and we’re not too pumped about earning pretax money market yields. But we’ve made the alternative mistake (i.e. forcing something) enough to not do it again.

Longleaf Partners Fund’s largest equity position is Vivendi, at 6% of assets. Cash is at 25%, a little more than four times that amount.

Cash Holdings: The Most Contrarian Asset Possible

At the Clipper Fund’s annual meeting in March, lead manager Jim Gipson explained why the fund is holding 34% of its assets in cash and short-term securities. "The Federal Reserve, with its Fed funds’ rate of 1%, has made it extremely difficult, even painful, to hold short-term funds. For example, at this rate, your money market fund will double every 140 years… this is not a good time to be invested in long-term assets now…and for that reason, we’ve pulled back and increased the most contrarian and uncomfortable asset possible – which is short-term cash." Gipson has a strategy about maximizing his cash yields.

Tweedy Browne likes using repurchase agreements for short-term cash. It has 0.3% in T-bills and 16.3% of its Global Value Fund in repurchase agreements, or repos.

The Sequoia Fund is run by former pupils of Ben Graham and was recommended by Warren Buffett. They’ve got 35% of their money in Berkshire Hathaway, their largest position. The rest of the Sequoia Fund’s assets are in just 13 stocks. Sequoia reported holding 14.41% cash at yearend 2003. Sequoia is the most highly concentrated fund I know of, and its largest holding (Berkshire) holds 25% of it market cap in cash, and its second largest holding is cash itself. That comes out to about 23% of Sequoia Fund assets in cash. (.25 X 35% + 14.41% = 23%.) Sequoia has turned every $1 invested with it in 1970 into $151 dollars today.

Alan Van Den Berg of Century Management has earned his clients a hair under 130-times their money since 1974. He agrees with the cash holders. A few months ago, Van Den Berg told his clients that, "Today, I’d say that, once again, you’re better off being in a money market fund. Even if you’re only getting three-quarters of 1% on your money, if the economy recovers, interest rates are going to go back up. Short-term rates will rise 3-5%. So you’re not going to be at 1% forever…the most hated investment today is cash. Everybody hates cash. Nobody can stand to be in cash. By contrast, everybody just loves being in stocks. At the bottom of this bull market – back when it began – 50% [sic] of mutual funds were money market funds."

It’s one thing to wind up in cash because you’ve sold stocks, which is how Jim Gipson characterizes his large cash position. He’s simply found more stocks to sell than to buy. But Van Den Berg’s advice is of a different character. Van Den Berg says you’re better off in a money market fund than anywhere else. Money market rates, puny as they are, outperformed the S&P 500 in the last five calendar years. In fact, the S&P 500 actually lost money during that time. All of the above is why yours truly has approximately 84% of his liquid assets in cash, and the rest in stocks.

Cash Holdings: Own What You Hate

Echoing Van Den Berg’s comments, contrarian money manager David Dreman writes in his latest annual shareholders letter, "Anybody can own what they like. The challenge is to own what you hate." I couldn’t agree more. I recommend that you take Dreman’s challenge, sell overvalued stocks and bonds you may be holding, and make cash – the most hated asset today – your largest holding.

If a consensus among these investors makes you wonder if the idea of holding cash is about to become a bad one, take heart: There are at least two dissident fund managers among the great value investors of our time. The first is the duo of Bill Nygren and Henry Berghoef at the Oakmark Funds. They’re only holding about 3.8% of their assets in T-bills and another 2.1% in other highly liquid short-term government agency securities, for a total of 5.9% in cash. Nygren and Berghoef’s largest position is in a bank, Washington Mutual (WM), which makes up 17% of the Select Fund’s assets.

Bill Miller is even more fully invested than Oakmark. Miller is the manager of the Legg Mason Value Trust. At the end of 2003, he became the only investment manager ever to beat the S&P 500 index 13 years in a row. So we have good reason to call him the best stock picker of the last 13 years. Miller finds value in franchises and market leading brand names, even if it means buying and eBay. Miller’s most recently published shareholder report says he’s got 98.9% of his money in stocks, and just 1.1% in cash.

At 16.4 times earnings, the S&P 500 is near its historical mean valuation of 16 times earnings. It’s been above that level most of the time since 1995. If you’re going to buy stocks, you still need to be careful, and buy only what is safe and cheap enough. No matter what you’re doing with your money right now, be aware that cash is king; make sure you have more cash than anything else.


Dan Ferris
for The Daily Reckoning
June 29, 2004

We are just all a-tingle here at the worldwide headquarters of the Daily Reckoning.

Nothing has happened in the financial markets for a long time. Frankly, we were getting a little tired of it.

Now, something is about to happen – this week – even if it seems so little that it is less than nothing.

We are not referring to yesterday’s hand-over of ‘sovereignty’ to the Iraqis – at least to those Iraqis believed reliable by the U.S. government. No, we are talking about a different kind of humbug altogether.

If hypocrisy is the homage that vice pays to virtue, 25 basis points must be the Fed’s homage to responsible monetary policy. The inflation rate (CPI inflation as measured by the Commerce Department) is running about 3% per year. If the Fed were serious about protecting the nation from rising inflation rates, you would expect it to lend money for no less than actual inflation. At 1.25% – the anticipated rate following this week’s announcement – it will still be giving money away.

Still, what is important about this week is that even the 0.25%-increase represents a ‘baby step’ in virtue’s direction. Having spiked the punch wantonly for years, now the Fed begins spiking the punch slightly less wantonly. Doing so, it brings to an end – or so it is widely believed – an era of falling rates that began in the early years of the first Reagan Administration.

"By the time their two-day meeting ends on Wednesday," explains the International Herald Tribune’s report, "they are all but certain to have laid to rest an economic era that has lasted almost 25 years."

Rates rose as high as 20% in 1980. Then, for the next quarter of a century, they fell. Pulled down by a 1% fed funds rate, yields dropped to a 46-year low in June of last year, apparently completing the bull market in bonds. Yields are higher than they were a year ago. But the 1% lending rate of the Fed remains. It is expected to grow 25% tomorrow, marking the end of a quarter century-long trend.

What happens next?

"What may be most worrisome," continues the IHT, "…is that rising rates often expose problems that were papered over by the benefits of ever-cheaper credit…

"The biggest question may be whether the millions of people with adjustable-rate mortgages will be able to meet their payments without making big cuts in the rest of the budget."

The New York Times elaborates:

"Joyce Diffenderfer is beginning to wonder how she and her husband, Curtis, will deflect the growing cost of their $16,000 in credit card debt.

"Not that her concern is a pressing issue yet; it is more like a fire drill in anticipation of a fire that she is still not convinced will occur. The Diffenderfers figure that a modest rate increase would initially add only $35 to their monthly card payments, which now total more than $600. Still, they have run out of ways to sidestep the cost of borrowing, and if the rates keep rising, as the Fed’s leaders suggest they will, then the only alternative, Mrs. Diffenderfer said, will be to seriously cut family spending.

"The Diffenderfers are among the millions of American families who rode the recent wave of low interest rates to home ownership and the rapid accumulation of debt, and now they must cope as rates begin to swing upward."

A man who has learned to live paycheck to paycheck in a 1% world may find the world less friendly after Mr. Greenspan makes his nod towards responsibility. A 1.25% world will probably pose little problem. But surely a 5% world will cause him trouble. As for a 10% world…or 20% world (such as we had when Paul Volcker was at the Fed)…we don’t even want to think about it.

Of course, Mr. Greenspan still has his flask in his hip pocket. We do not doubt that he will unscrew the cap from time to time – generally keeping rates below where they ought to be. Perhaps he really wants to destroy the dollar – just to prove he was right about gold 40 years ago. Most likely, he is just following Fed tradition. Compared to gold, the dollar is worth only 2.5% of its value when the Fed was set up to protect it in 1913. When people say they have faith in the Fed, they no longer mean they expect the Fed to maintain the stability of the dollar. Rather, they mean they count on the Fed to destroy it at a measured, reliable rate. How well they achieve this dubious goal will be the subject of our reckonings going forward.

There are things we know now, dear reader, and things we will know later. What we know now is that the Fed pursues it mission – financial stability – in a curious way. It has presided over the destruction of the dollar; by fits and starts, the greenback has lost 97.5% of its value in the last 109 years. We know, too, that the Fed can put the key lending rate as low as 1% or as high as 20%…and plague Americans with inflation rates of about the same range.

We know what happened after the Fed squeezed credit in the Volcker years. What we will know later is what happened after it got let loose in the Greenspan era.

Over to you, Eric, for the latest latest…


Eric Fry, from Penn station in NYC…

We Americans generously handed over Iraq to the Iraqis yesterday…so far, the Iraqis have not handed it back. But the country is quite different from the one that Saddam Hussein once called home. Now that the U.S. Army has liberated the place, Iraqi terrorists have never felt freer in their lives. They too may now enjoy life, liberty and the pursuit of happiness, jihad-style.

We doubt that any government – American or Iraqi – can quell the unrest that spawns one terrorist attack after another. And we also doubt that the "handover" signifies any significant change to the status quo. The American Army still occupies the place, even if the Iraqis are "in charge." And as long as U.S. troops are milling about the country, Iraqi militants will target them.

"We find it almost intellectually dishonest," says Smith Barney strategist Tobias Levkovich, "to conclude that the handover to an Iraqi sovereign government ends the casualties, the occupation, the violence, the U.S. financial burden, and thus, related equity market fears."

If not intellectually dishonest, self-delusional…nevertheless, investors greeted the transfer-of-power charade with a brisk mid-morning rally. Share prices continued climbing on word that the American consumer continues to spend money he doesn’t have on things he doesn’t need. Consumer spending soared 1% in May, while the savings rate slumped from 2.6% to 2.2%.

The feel-good vibe eventually faded, however, as investors second-guessed their initial exuberance. The Dow coughed up more than 100 points from the day’s high to finish the session down 14 points at 10,357, while the Nasdaq Composite fell 6 points to 2,020.

Maybe share prices fell yesterday afternoon because the lumps started to worry about today’s Federal Open Market Committee (FOMC) meeting and the widely expected rate hike that will follow the meeting. Most folks expect the central bank to raise rates by 0.25 percent, or 25 basis points. The move would be the Fed’s first increase since May 16, 2000.

Or maybe the lumps were troubled that long-term interest rates are climbing already, even without Alan Greenspan’s permission? Already, the benchmark 10-year note fell 3/4s of a point yesterday, pushing its yield higher, to 4.75 percent from 4.65 percent on Friday.

We don’t know dear reader, but we suspect we might find out quite soon.


Bill Bonner, back in London:

*** Sean Corrigan sends this telegraphic alarm:

"Combined new and existing-home dollar-turnover [is] now a record $1.952 billion…[it has] doubled since LTCM emergency liquidity in Oct ’98… and prices are up 50% in that time…

"Average Price/ Average hourly wage [is] now $15,285…26% and 12.2 sigmas over jan89-may98 mean. It now takes 7 yrs, 7 months’ money rather than the old 6 years to buy one for cash (as if!)

"Dollar Turnover/wage fund (wages x payrolls x hours) now 75% and 10.1 sigmas over jan89-nov-01 mean…"

*** We went out this weekend for a second inspection of a château for sale. Your editor cannot resist a pretty stone. It says nothing, yet it beckons to him sweetly like a dead man or a lump of gold.

The pile we were looking at was in Normandy. It was built by one celebrated Frenchman, just before the revolution, and lived in by another. It sits in classical splendor – solid stone with a Palladian front and two 18th century wings – on green fields of 370 acres. Inside, the place is depressing. The owners seem to have run out of money and energy. Paint peels from the walls, plaster cracks run in every direction. Carpets look like they were last shaken out in the reign of Napoleon III. The place has scarcely changed since the siege of Paris in 1870. But there is a touch of modernity. Rusty radiators – with little cups under the valves to catch the leaks – reveal a hint of heat. Cloth-covered wires suggest electricity. In one room, an old man watches television.

Your editor’s pulse quickened. He is a deep-value investor, a do-it-yourselfer and a stone-lover. Here, there were stones all over the place, not just in the main house, but also in the stables, greenhouses, poultry houses, barns, chapels, and garden walls – everywhere. Here was real value…and things he could do-it-himself with for many years.

Location is everything in real estate. This magnificent property costs no more than an average house in La Jolla. At least, to purchase. The real expense comes later – when you go to fix the roof…or paint the 20 bedrooms.

"Well, what do you think of it," he asked Henry after the visit.

"Hmmm…I think it is pretty nice. But, there’s so much work to do…"

"Yes, but I like this kind of work. These are projects we can enjoy."

"Dad…you mean YOU enjoy them. You’re going to make us come out here and work every weekend, aren’t you?"

"Well, not every weekend. And besides, it is good for you. You learn how to do things. It builds character."

"Dad, we helped you with that house we built in Maryland. And then we’ve spent the last 8 years restoring that house out in Poitou. I think our characters are okay already."

The Daily Reckoning