- Martin Fridson, CFA
Cash is (almost) King!
Cash is back in style.
Money-market funds saw their assets grow by $2 billion in between year-end and January 17, 2019 according to Thomson Reuters Lipper. Cash allocations in investment portfolios are up for the first time since 2011, Goldman Sachs reports. The Wall Street Journal’s account further notes that those percentage allocations reached an all-time low last year.
Investors’ desire to take some money off the table after a rapid run-up in stock prices is not a new development of the last month or two. Neither is there anything new about the widespread hunch that keeping some dry powder will pay off as better buying opportunities emerge down the road. Whatis different from most of the last ten years is the reduced sacrifice that sitting in cash entails.
Source: Bloomberg Professional Services
The accompanying graph shows that for most of the period since the January 2008 commencement of the Great Recession, the yield on three-month Treasury bills was less than the dividend yield on the Standard & Poor’s 500 Index. From its 0.00% trough in September 2015, the T-Bill rate steadily climbed to 2.30% as of January 22, 2019. Over the same period, the S&P 500’s yield declined from 2.25% to 2.06%.
When the stock index’s yield exceeded the T-Bill rate, investors who thought stocks were fully priced might have reasoned as follows: “The portion of my wealth I keep in stocks is going to be dead money for a couple of years until earnings catch up with valuations. But at least I’ll earn some dividend income while I wait.”
Under the new conditions, investors who expect a flat market think that they may have a better alternative. They can collect a higher yield, without the downside of stocks, by owning short-term obligations of the federal government. Furthermore, the interest on a T-Bill is a fixed contractual payment, while a corporation’s dividend can be reduced or eliminated by the Board of Directors.
The rise in the three-month T-Bill rate has also eliminated one previous objection to the instrument. At the low yields that prevailed for most of the past decade, investors were setting themselves up for negative real returns. At 2.30%, the T-Bill rate slightly exceeds the 1.9% (2019) and 2.1% (2020) median forecasts for the Personal Consumption Expenditure price index reported by Bloomberg.
An important caveat is that interest rates on bank deposits have not risen in the same way T-Bill rates have. Banks have not passed along the rising yields to depositors. So if you want to keep some money in cash for the time being, use T-Bills or a money market fund, rather than CDs.
“For the time being” is the key phrase. The reason to hold cash at present, other than to satisfy ordinary liquidity needs, is to take advantage of better investment opportunities in the future than you perceive to be available at present. Over an extended period, maintaining a large cash component creates a significant drag on returns, since the other major asset classes—equities, fixed income, and real estate—provide higher returns as compensation for their greater risk.
The bottom line is that with the previous penalties for holding it now out of the way, cash can once again be regarded as an asset class with investment merits. However, this is likely to be a temporary situation. Should economic growth accelerate, so will inflation, turning the “real” yield on cash negative (your dollar tomorrow including interest received will be less than a dollar today.) Alternatively, should the economy go into a recession interest rates may drop again and yields on other investments may become more attractive.