This article is a guest contribution by John Hussman, Hussman Funds.
Just a note - if there is one weekly comment that I hope that regular readers of these comments will not miss, it is last week's piece - Valuing the S&P 500 Using Forward Operating Earnings. Economic risks and credit strains will come and go, but one thing that will remain important to investors over the very long-term is the ability to properly assess stock valuations. I know that last week's comment had more math than usual, which isn't everybody's cup of tea. But it's nothing that you can't do on a standard calculator, and even if you don't use the equations, I strongly encourage investors to read the comments carefully.
It's not always obvious to the listener when an analyst's argument is full of holes, but you should always be on red alert when a single year of earnings is taken, at face value, as the basis for market valuation. If you passively accept that premise without training your neurons to revolt like little Frenchmen at the gates of the Bastille, you'll be at the mercy of all sorts of false and misleading claims about valuation based on models that have absolutely no predictive reliability in historical data. In the absence of historical evidence, people can say anything they want without accountability.
If there is one thing that is singularly responsible for the abysmal returns of the S&P 500 over the past 12 years, it is the ludicrous set of valuation "models" that Wall Street has repeatedly foisted onto an uninformed public in order to sell them on the notion that dangerously overvalued markets were actually "cheap." Knowledge is your best defense. Valuation matters.
Corporate "cash on the sidelines"
Four years ago, in There's No Such Thing as Idle Cash on the Sidelines, I observed:
"Investors should not believe that the “cash on the balance sheets” of corporations might suddenly be used, in aggregate, for new investments and capital spending. That cash on their balance sheets has already been deployed as loans to the Federal government and to other companies. Now, yes, if the government runs a surplus and retires its debt, in aggregate, or the other companies that borrowed the money generate new earnings and then pay off their debt, in aggregate, then those new savings that retire the T-bills and commercial paper then make it possible for the recipients to finance new investment, in aggregate. So as usual, savings equals investment, and new savings can finance new investment. But what investors often point to and call “cash on the sidelines” is really saving that has already been deployed and used either to offset the dissavings of government or to finance investments made by other companies. Once those savings have been spent, you can't, in aggregate, use the IOUs (in the form of money market securities) to do it again."
Now, as then, analysts are pointing to an apparent pile of corporate "cash on the sidelines" as these holdings of debt securities somehow make new corporate spending more likely. In order to evaluate this argument, it's necessary to understand that what is being called cash is actually a stack of IOUs for money that has generally already been spent by other companies or by the government.
