Why has the Edge Fund has been fully invested since May?

This chart below explains why we have continued to be at least 95% invested since the end of May.  We are currently 98% invested and holding just 2% cash.

Probability of good things happening has increased
During July, the ASX finally broke above the sideways price movement going back to October 2013. From my view point, this means that the probability of good things happening for share prices in aggregate has increased.

I have been sharing updates of this chart for the past few months with those invested in the Edge Fund.

The weekly chart of the ASX All Ordinaries shows that breakout above the top of the arrows at the 5500-odd point level.  The time between the arrows represents a nine month (October to July)  sideways consolidation.

(click to enlarge)

Today’s investors are living in unprecedented times

In 1994, the US market endured a similar sideways movement for a little over 12 months prior to enjoying a bull market run for more than a year.  However, in Australia, we have to go back to the 1960’s to see a sideways consolidation of the same duration.  And, yes, after that long consolidation in the 1960’s, what followed was over a year of strong gains.   I doubt many people reading this were actively investing in the 1960’s which means that today’s market participants are certainly operating in unprecedented times.

The longer we stay above that 5500 breakout level on the ASX All Ordinaries (about 5540 is the equivalent on the ASX200) the higher the probability of this upside continuing.

Cash on the sidelines is finding a home
With record low interest rates forcing people to look beyond bank term deposits, it seems enough of this money is now collectively finding its way into the share market.

The current consensus is to hold 30% cash
I have observed a number of fund managers over the past couple of months on business TV programs such as Switzer and CNBC talk about the market being “fairly priced” or “fully priced”.

These fund managers have cited this ‘fully priced’ reason to hold cash levels of about 30% as a consensus. Holding the consensus view may be safe on their part because if everyone else is doing it (holding cash), than they won’t look bad relative to their peers.  But, I do wonder if holding high levels of cash at this point is in the best interest of their clients, those who have invested in such funds?

I have only seen one fund manager on these business programs holding just 5% cash to his credit, but a couple others holding 40% cash and one fund holding 50% cash!!!

Holding cash in a rising market will likely equal under performance

  1. A fund holding 30% cash meaning they are 70% invested have to rely on the stocks they hold outperforming the market by 43% in order to keep pace with a rising market.
  2. The manager holding 50% cash (ie only 50% invested) has to rely on their stock picks rising twice as fast as the rising market just to keep pace.

So, while fundamentally, the rationale of these fund managers is correct to hold higher levels of cash.  In practice, given the positivity now shown on the charts as an aggregate of the sentiment of all investors in the market place, it is likely those holding high levels of cash will under perform the market until the positive sentiment drifts away.

Good news
The good news for those heavily invested is that the longer the All Ordinaries stays above this 5500 breakout level, the more pressure those fund managers holding high levels of cash will face.  If this breakout holds and continues higher, the fund managers holding a lot of cash will have to make a decision based on two choices:

  1.  Stay wrong (stay with relatively high cash levels)
  2. Chase the market higher by putting some of their cash to work

A combination of the two will probably prevail.  I think their is a distinct possibility that those chasing the market higher and trying to find ‘pockets of value’ will most likely fuel higher share prices in the months ahead.

Waiting for opportunities or an opportunity cost?
Another rationale given by many fund managers is that they are holding cash waiting for opportunities. I use to subscribe to that way of thinking because everything I read and heard from experts told me this was the best approach.  Fortunately, I am no longer on that band wagon.  Here is why……

  1. I currently have more good ideas than cash.
  2. I have a simple solution when I am fully invested (which I am) and a better opportunity does come along.     
    I will simply sell half of my two most expensive or a third of my three most expensive holdings relative to value in order to free up enough cash to buy a full position in what is now the best opportunity for investment gains.

Perhaps, just maybe

And perhaps, just maybe, those holding cash waiting for ‘opportunities’ have just missed the best opportunity they may have for a year or two to buy the cheapest stocks on dips during the last nine months.

Monitor and Adjust instead of Forecast
Assuming the breakout holds, I hope I am good enough to stay the course until the market tells me the probability of good things continuing is coming to an end.  It could be a week, a month, a quarter or a year from now.  I have some views that it could be well into 2015 at this stage but would prefer to ‘monitor and adjust’ rather than stick to a forecast. I plan on holding until the market profile morphs into something that looks more like January 2008 or May 2011.

Beating a rising market will not be easy
We hold a diversified portfolio of companies that in aggregate have stronger fundamentals (higher profits, lower debt levels and better cash flow) than the average stock on the market.  While beating a rising market will not be easy if it persists, I believe that the fundamentals of the companies we hold can lead us to outperform the broader market even if it does continue rising.

Happy investing !!!!

This article is published by Dean Mico.

The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person, nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.

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