On market timing… Part 4: Transitional dynamics of Saving and Dissaving.

What makes more sense than selling when everybody else is selling? Selling assets while the demand (money flow) for those assets is still strong; a liability imperative should force investors to sell higher risk investments at fair to high absolute market valuations and avoid selling at low valuations.

An important function of the market place is that of allowing the opportunity for consumption of capital; this does not work effectively for risky assets during market and economic crisis. However, at most other times traffic can move both ways, with marginal sellers of equities (and other higher risk assets) receiving more or less their full market value. The extent, to which, investors can sell higher risk assets in exchange for cash, depends on a number of factors.

1. The rate of money supply growth and, within this, the rate of asset focused money supply growth, and the increase or decrease in the preference for holding cash in the portfolio.

In Japan, cash represents some 50%[1] of household assets, up from 30% in 1990[2]; broad money supply growth also sharply decelerated in the 1990s from the asset bubble’s peak[3].

2. The distribution of wealth across the market place; very wealthy individuals will not need to adjust asset allocation for liability concerns, while less wealthy individuals may well consume more or less all their investment assets during their lifetime.

In the US, 1% of the population holds 50% of the wealth and, most wealth is held by those close to or in retirement.

In the UK age groups up to and including the 50 to 54 age group are in a net debt position; only those are 55 and above are in a net asset position[4].

3.  The extent to which the wealth of the newly deceased is transferred as is or is sold; this releases a supply of equity and fixed interest and property etc for all market segments.

4. The demographics of saving and consumption and its impact on final demand for output – see sections 3 and 4 for further information regarding the importance of final demand for asset pricing and asset allocation.

Just for the sake of analysis; if 60% of the market place is held by those close to or in retirement, but only 50% of those (30% of the market place) assets are held by those looking to partially or wholly consume capital over time, then a 10% increase in money supply(allocated to equities[5]) and a reduction in the other 40% of the market’s cash holding preferences by 2% (from whatever starting figure), would allow those consumers of capital to sell 3.7% of higher risk assets for cash. If the average gross consumption of those consuming capital was 4.5% and the gross yield was 2.5%, then the gross differential would be 2%. Divide 3.7% by 2%, and we have 1.83, or an additional 1.83 years of capital needed to meet future financial needs.

If those close to, or, in retirement, but not needing to consume capital, wanted to reduce their cash allocations, then a higher level of cash could be raised by those wishing to do so. Not everybody in the need-to-realize-camp would do so, meaning that the leeway for those who wanted to raise capital for consumption would be greater. Other factors important to the transitional dynamics of the market include but are not limited to the following.

A. Up to age 55 or older, people accumulating capital, may not even need to transfer equity capital for lower risk assets since there may well be sufficient savings out of income to achieve the transition.

B. While in retirement, absolute demand for real allocations to fixed income should remain constant (assuming real expenditure remains constant), in the absence of excess market valuations. The balance of demand and supply for fixed interest will be impacted by deceased investors (estate selling assets), and new or close to retirement investors accumulating lower risk assets.

C. Not every individual will need to manage liability risks; very wealthy individuals will either be able to meet all income and capital needs from dividend and interest income (or sources of earned income) or even continue to accumulate as interest and dividends are reinvested.

D. Those who are consuming capital in retirement will see cash balances falling; portfolio structure and management should be focused on managing the ability to generate cash for consumption purposes. As such, dissevers will be spending cash and looking for ways to realize capital, and those who are saving and accumulating, will be increasing cash and looking for ways to invest excess cash balances.

The importance of the transitional dynamics of markets confirms one of the problems with market timing indicators; these indicators need confirmation of changes in price and volume, by which time the opportunity for investors to exit strategically for consumption purposes would risk being impaired – we would have market timers competing for demand. Waiting to time the market for the management of liability risks is counter intuitive.

[1] http://uk.reuters.com/article/marketsNewsUS/idUKT34688720070918

[2] http://www.tcf.or.jp/data/20051121-22_Sachiko_Miyamoto.pdf

[3] http://www.nli-research.co.jp/english/economics/2000/eco0007a.pdf

[4] http://libsurvey.essex.ac.uk/reports/2006LIB_RR.htm

[5] The actual increase on broad money supply towards investors would be skewed towards who are directly impacted by areas benefiting from money supply increases. Retired investors with a greater proportion of fixed asset allocations would have a smaller share of any increase. If money supply growth is in excess of nominal GDP, then those reliant on assets alone for cash flow would receive a still smaller percentage of the increase in money supply.

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