Are Stocks, Bonds, or Cash King?

09/10/2007 12:00 am EST

Focus: STOCKS

Kelley Wright

Managing Editor, Investment Quality Trends

Kelley Wright, managing editor of Investment Quality Trends, goes through the different purposes of different asset classes to determine what investors should do now.

A market correction is a process that takes time, and this time won't be any different. The bounce at 12,600 [in the Dow Jones Industrial Average] was predictable because the 1,400-point decline from Dow 14,000 represented a textbook 10% correction. At some point the market will want to establish whether Dow 12,600 was the bottom. My thought is that we will know soon.

Frequently, in both my writing and when I speak publicly, I make reference to the three primary asset classes: stocks, bonds, and cash. The purpose of investing is to consistently increase the amount of money one has to invest so as to consistently increase the amount of income one can spend on current and future cash needs. Of the three primary asset classes, in my opinion, the most appropriate for the purpose stated above is stocks; more specifically, select blue chip stocks, [like Colgate-Palmolive, Johnson & Johnson, PepsiCo, and McDonald's.]

Often, I am asked whether I am being too simplistic in limiting my discussion to just these three asset classes considering the myriad investment options available in the modern financial marketplace. With recent events in the credit markets fresh in most investors' memories, I am presented with a convenient opportunity to answer the query.

Cash is a primary asset class because, well, it is money. We need money to pay for the things we use and need. (As a quick aside, I chuckle when neighbor Richard Russell of Dow Theory Letters tells of trying to pay for something with a one-ounce gold coin and the clerk told him they only accept cash or credit cards!)

Bonds are a primary asset class because they represent a fixed income stream for a specific period of time, contain a promise to return the principal on a date certain and, if need be, the highest grade issues such as Treasuries and Government Agencies are also liquid. (They can be turned into money.)

Stocks, when they are high quality and offer good value (read: select blue chips), are generally liquid. The real value of a stock, however, is in its underlying dividend, which once again is real money.

Derivatives, which consist of collateralized debt obligations (CDOs), credit default swaps, and other exotic mechanisms-well, they just aren't money. Subprime mortgages and certain other types of asset-backed debt are not money. A lot of things that the markets have treated as a store of value or a medium of exchange are simply not money.

In summation it really is about the money: cash, it appears, is still king.

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