Sensitivity and Risk Aversion
If you play with a snake, you shouldn't complain about getting bitten.
How sensitive are we to a rise in short-term rates? In less than 24 hours now I have seen two articles that mention the growing attraction of cash. The latest article is here in the Wall Street Journal's "Ahead of the Tape" column. Note this sentence from that article: "The 10-year Treasury's current 4.39% yield doesn't pay investors much to take on the extra risk of being locked into a long-term instrument."
As the market context according to the indicators I follow remains in high-risk mode, it is interesting to see risk aversion and a decrease in time preferences begin to crop up in the mainstream financial media. That is precisely what that sentence quoted above outlines: investors are on the precipice of perceiving that the risk of being locked into a 10-year instrument is not as attractive when a short-term instrument yields almost as much - a decrease in risk tolerance and time preferences.
Since the Fed's latest campaign to eliminate cash as a competitive asset class begun, stocks such as Microsoft (MSFT), General Electric (GE) and Wal-Mart (WMT) essentially have become proxies for cash. Although I disagree with Professor Schaeffer's view that there is a lack of true structural vulnerability in homebuilders, utilities, REITs and small caps (please also read Jason Goepfert's excellent piece this morning on the small caps vs. large caps), I do agree that there remain excesses in mega-cap favorites.
In my view, structural vulnerability, by definition, means that any underlying layer of demand created by high short-interest and analyst upgrades will be small comfort in a true psychological shift from risk taking to risk aversion and from increased time preferences to decreased time preferences. The view that cash is potentially again a competitive asset class coincides with such a structural shift, and is a necessary step in the process until people realize that the "safety" of their cash is itself threatened, at which point gold begins to appear once again in the pages of the mainstream media... not cash.
One thing that we may all look back on and in hindsight view as a harbinger of things to come is the fact that gold has not materially broken down throughout the cyclical rally that began in October 2002. I believe there is a small probability that stocks continue to meander higher, and a significantly higher probability that stocks actually break down here. It is a risk vs. reward-based opinion, and I am prepared for the possibility that if I am wrong I will not make as much money as the prevailing consensus, and that I may even lose money.
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