In an Economy Stretched to the Max, How Liquid Are Your Investments?

In recent weeks, I’ve written predominately bearish pieces with respect to my view of the market. And, of course the market has claimed higher.

My views aren’t intended to be precise market timing calls. Rather, I’m focused on risk management: Is now a good time to allocate new capital to equities? Should I take on more leverage? Should I tighten my protective stops? Should I take some money off the table?

It’s impossible to know exactly when a market will top or bottom. So, while I’m not trying to pinpoint an exact top, I am suggesting that we are at the extreme end of the risk spectrum for owning equities and it’s better than not to proceed with caution.

My latest concern is household liquidity. This is the amount of liquid, non-equity assets households have relative to the value of the stock market. I’m talking CDs, government bonds, money market accounts, and a few others.

On this basis, we are stretched to the max.

According to the chart, when this ratio is at 49% and below, equity returns are negative. We are currently at 39.8% — nearly the same position as the 2008 market top! Other than that time period, this represents one of the lowest rates over the last 60 years!

In other words, investors have too much allocated to the stock market and not enough stored in liquid assets!

When the stock market finally does tank, the pullback will be sharper than normal. Most households are going to scramble to reallocate their funds to these liquid assets, only to find they’re too late! They’ve already been gobbled up!

We saw this in 2009. After the market hit its bottom, households raised more liquidity than at any time since the early 1990’s by selling stocks at depressed levels, when they should have been putting money back into the market.

Collectively, households do the wrong thing at the wrong time. Right now, investors should be returning to liquid assets, not shoving capital to the stock market.

John