The SP 500 (NYSEARCA:SPY) is expensive. The stock market price is currently about 119% of the GDP. Average annual total returns from that level is historically less than 1%. The cyclically adjusted price-to-earnings ratio is about 26, 58% higher than average. This is 92% as high as it has ever gotten. The 1929 peak with 97% and the 2007 peak was 95%. The tech bubble constitutes most of the period that was more expensive than the present. The implied future annual return is slightly negative. Globally, the price-to-sales ratio is as high as it has ever been.
Globally, the US market is one of the most expensive. Only two country markets have pricier CAPE ratios. The US market is also expensive relative to earnings, book value, sales, cash, and dividend yield. The only inexpensive country markets, such as Russia, have serious problems with both their economic and political systems.
Given the current opportunity set, how much of a portfolio should be allocated to cash? A lot. I don’t know the right answer with any precision, but it is probably somewhere between 20-30%. In Preparing For A Market Collapse, I discuss the problems with value at risk/VaR and other Greek-based risk models and instead argue for sizing discipline and plenty of cash. As I argue in Contra Excess Cash, too much cash is a theoretical problem that almost never exists in practice. I don’t say this out of pessimism about our current opportunities as much as optimism about the future opportunities that will require having more liquidity than our average counterparty.
It is easier to come up with obviously terrible answers than it is to come up with obviously terrific ones. Venezuela offers a currency that is so bad that its printers are starting to refuse to print it. They can’t pull their payment off of the press fast enough to make it worthwhile. Its neighbors at the bottom of the Index of Economic Freedom – North Korea, Cuba, and Zimbabwe – are similarly flawed. But the top – mostly made up of a few ex-Brit city states in Asia, the Anglosphere, and some of the colder European countries – are not necessarily safe. As I suggested in January, it may make sense for American investors to diversify out of the US dollar,
The US dollar has been strong for the past few years versus most other currencies. If you are approaching retirement, it might make sense to at least partially diversify out of US dollars (especially if you intent to spend much of your retirement travelling abroad). One convenient way to do so is by shorting or writing calls on the PowerShares DB US Dollar Bull ETF (NYSEARCA:UUP).
It is down over 4% since then, but the idea remains sound. I also split cash accounts between US dollars and Canadian dollars. Depending upon where you live, it might be ideal to have bank accounts on both sides of the border.
One allocation that helps further diversify your cash portfolio is bitcoin. I bid in the last government auction for 30,000 BTC and will probably bid on the next one for 24,518 BTC if I think I can get them for a good price. Ernst Young is managing the process for the Australian government on June 20.
How much BTC should you buy?
10% of your cash portfolio or 2-3% of your overall portfolio is probably about right. I would start with that and then allow it to grow over time with the increased acceptance of electronic currency.
Where do you buy Bitcoin?
I would start by avoiding publicly traded trusts trading at a discount. For example, Bitcoin Investment Trust (OTCQX:GBTC) is crazy:
As for me, my BTC wallet is at Coinbase. If you buy $100 of bitcoin or more on Coinbase, we’ll each earn $10 of free bitcoin, so this is the ideal place to set up a wallet and buy a BTC or two. After that, I would also look here for subsequent BTC purchase; it allows you to buy BTC with credit cards (as a purchase, not a cash advance) which means that you can collect BTC while also getting credit card rewards. I have made as much as $250,000 per month of such purchases specifically for rewards. They also offer Ethereum.
It is common practice to diversify between equity, credit, and cash. It is somewhat less common to thoughtfully diversify within cash. But 100% allocation to US dollars could be an extreme folly. Many sound alternatives exist including other sovereign currencies and bitcoin. I would consider putting 10% of your cash in bitcoin. Whatever happens to it in the days or weeks ahead, over the long term it is likely to gain wider acceptance and usage.