Thursday, April 13, 2006

With Gas Prices Rising, It's "Smart" to Raise Cash

Rising energy prices and interest rates pose a significant risk to economic growth. Crude oil is now close to $70 per barrel, and the futures price of gasoline is well above $2.00 per gallon. According to the AAA, as of today, the average retail price of unleaded gasoline is $2.72. Where I live in New York, it's more like $2.90.

I've been warning for quite some time in the Forbes Growth Investor that the economy can't continue to thrive indefinitely if high energy prices persist. Now that gasoline prices are on the rise, I'm even more concerned. Furthermore, we just saw the yield on the 10-year Treasury note rise above 5%. This double whammy of high energy prices and rising interest rates leads me to recommend a more conservative asset allocation. Investors should decrease their exposure to stocks and hold more cash and short-term notes. At a time when many market prognosticators are saying equities will provide only single-digit returns, what's wrong with holding cash? The fed funds rate is likely to go to 5% in May. Cash will give you a reasonable return with no risk.

Please note that I am not recommending that you get out of stocks completely. I'm simply saying that it makes sense to reduce your exposure. Of course, the actual allocation for an individual would depend upon his/her objectives and constraints. Nonetheless, I think at this time, most investors would be well advised to have no more than 50% of their portfolio in stocks.

As mentioned above, gasoline prices are on the rise. Yet DaimlerChrysler is facing tremendous pressure to shut down its Smart car unit. Many Americans aren't familiar with these small two-passenger vehicles, but they are quite popular in Europe. Daimler has been considering offering them for sale in the U.S. The cars are extremely fuel efficient and suprisingly safe. But the company has been losing money on them. With energy prices unlikely to fall back to the levels we were used to just a couple of years ago, consumer interest in fuel efficient cars will grow. It seems like a bad time to get out of the small-car business. If Daimler ever makes the Smart car available for sale in the U.S., I will be among the first in line to buy one.