Canadian investors are taking refuge in great quantities of cash, choosing to forfeit potential returns in exchange for relief from the market frenzy.
Heightened cash levels are an expected product of episodes of market volatility, such as the one that has sent investors retreating from risk assets this winter. Canadian investors have reacted by building up record-high personal cash buffers totalling $75-billion, according to the estimate in a CIBC World Markets report.
Cash has a legitimate role in a portfolio – its redeployment sowing the seeds of future returns once the markets recover.
The problem is that the average investor is a consistently lousy market timer. "The risk is that you wait too long, because markets can rally in a hurry," said David Burrows, president and chief investment strategist at Toronto-based Barometer Capital Management.
Investor behaviour in response to corrections follows a familiar pattern: They sell into weakness and raise cash, which they then sit on for too long to participate in the eventual rebound.
That phenomenon is cited in the CIBC report that shows Canadian investors accumulating cash hoards in response to the grim sentiment now reserved for the Canada's economy and its markets.
"With an ocean of fear dominating financial markets, Canadians have been swimming back to shore," economists Benjamin Tal and Royce Mendes wrote.
The amount of excess cash held in Canadian savings accounts now amounts to about $75-billion, the economists said. That's $75-billion above and beyond what the cash position would be under normal circumstances.
But the circumstances of late have been far from normal. The great shakeup in the global energy market, which took West Texas intermediate crude from $100 (U.S.) a barrel to less than $30 in a year and a half, has consumed Canadian markets as volatility has spiked worldwide.
Canadian stocks have tracked emerging markets and commodity prices in a race to the bottom, while benchmark five-year Government of Canada bond yields recently opened up a record spread of one percentage point against U.S. debt.
Everyone is betting against Canada, Canadians included.
Cash positions, including demand and notice deposits as well as money market mutual funds, have risen by 11 per cent over the past year, the report said.
Mr. Burrows said his own investment process resulted in a rising cash position beginning last spring as a decline in the number of stocks propping up indexes suggested a tired rally.
He effectively added to his cash weighting when market leaders began to be sold off in December. Now he's looking for indications of a market bottom and confirmation of a rally to start reinvesting that money. The S&P/TSX composite index has risen 7 per cent from last week's intraday low, after declining 26 per cent from last May.
"The only way to benefit from a correction is if you have cash to put to work when it gets better," Mr. Burrows said.
Investors consistently turn to cash through bouts of heightened volatility to try to limit paper losses. The risk of cash as an asset class, however, is that investors tend to move in and out of it at "precisely the wrong time," the CIBC report said.
Past corrections confirm the tendency. The 1987 crash lasted just two months, but investors built up cash over the next year and a half, during which the stock market rallied by more than 20 per cent.
"Ditto for the 2001 flight to safety when investors reacted almost immediately to the stock market correction by aggressively raising their cash positions," the report said. "But again, they failed to adjust these positions when the market began recovering, maintaining record-high levels during the bull market that began in early 2003."
And the latest bout of risk aversion is really a continuation of the cash hoarding that followed the 2008-09 recession.
"While holding cash can guard against short-term spikes in volatility, it's certainly a long-term drag on portfolio returns," the economists said.
The S&P/TSX 60 volatility index, now at a relatively lofty 25, has risen above the 20 mark eight times over the past five years. In the three months following, the TSX benchmark rallied by an average of 9 per cent, while investors were typically still moving to the sidelines, the report said. "That rebalancing means that investors are buying high and selling low," it added.