2018_12_15 — “Johnny Cash 2.0”
December 15, 2018
Johnny Cash 2.0
Johnny Cash 2.0
The return on cash and cash equivalents has improved over the last year: A year ago, in an article titled “Johnny Cash”[i], I advocated for cash and cash equivalents [ii] as a viable investment alternative to equities and fixed income in diversified and balanced portfolios after nine years of positive economic and investment performance; “Short-term rates are a positive yield generator: The front end of the yield curve will not only remain an attractive hedge against volatility elsewhere but will be a positive return generator itself.” Several reasons for this view were expressed:
- The monetary unwind of central banks which would disincentivize investors from taking risk
- The huge 46x increase in T-Bill interest rates from 0.03% in December 2014 to 1.4% by December 2017
- The 8x increase in LIBOR from around 0.2% to approximately 1.6% over the previous three years
Equities seemed fully valued, bond credit spreads were tight (expensive), U.S. markets seemed overly exuberant from President Donald Trump’s fiscal and deregulatory stimulus, and global manufacturing indices had almost all turned positive; in other words, it was hard to imagine additional good news that would further propel equities and fixed income markets much higher in value. “Over the last several years, as equities prices have risen (and become more expensive by some measures) and credit spreads have tightened (i.e., gotten more expensive: one is paid less for taking bond or loan credit risk), one major asset class has increased its annualized return near seven-fold without adding to traditional risk. That asset class is the seldom remembered and often disparaged, Cash and Cash Equivalents.”
90% of asset classes have negative year-to-date returns: Fast forward twelve months from December 2017 to December 2018, and U.S. equity markets are flat after a volatile year with many previous high flyers down over -20% from their highs, European, Asian, and emerging market equities are down approximately -5% to -15%, credit spreads are wider, the U.S. aggregate bond index is down -1%, and altogether 90% of asset classes have negative year-to-date returns. Cash and cash equivalents, however, have continued to perform well; three month T-Bills now yield 2.42% compared to 1.4% at the end of last year and 0.03% four years ago.
Cash remains a viable investment option even though it is often left out of many allocation decisions: Common portfolio allocation splits tend to be 60/40 in investment parlance, meaning 60% allocated to equities and 40% allocated to fixed income. Such parlance tends to ignore the potential tactical benefits of holding cash and cash equivalents in many portfolios (especially after a nine-year economic up cycle), as well as the potential benefits (and risks) of real estate or alternative investment exposure for other portfolios.
Cash is an earner, a hedge, and an opportunity: As expressed a year ago, the advantage and usefulness of holding cash in investment portfolios stems from its interest earned, its dampening effect on portfolio volatility, and its ability to be deployed into new investments; “Cash may or may not be king, but it is somewhere in the royal family: Don’t underestimate the value of cash in this environment as a stable earner, a risk hedge, and as a patient opportunity to wait for the next fat pitch (any intriguing prospect that comes from a market dislocation or selloff). If there is a market or asset pullback,… cash… will be immensely useful for the opportunity.”
Investors are not concerned about deflation: Since the great financial crisis, investor concerns about deflation spiked and submerged three times. Using data from Google Trends, market concerns about deflation peaked in late 2008, in the later half of 2010, and again in early 2015 [https://g.co/trends/oXLra].
Table 1. Google search trends for “deflation” from January 2004 to December 2018
In January 2015, the slump in oil prices dragged Europe into deflation as overall prices fell -0.6% and nudged the U.S. into a price decline of -0.1% from a year earlier. A recovery in oil prices and global growth subsequently pulled inflation numbers back up for most of the world.
Deflation is good for cash: Inflation erodes the relative value of cash whereas deflation enhances it; in an inflationary environment, a hundred dollars buys more today than it does in the future, but in a deflationary world — items get cheaper — a hundred dollars buys more in a year than it does today. Although deflation is a low worry now, if deflation concerns reemerged through recessionary indicators or an oversupply of commodities or manufactured goods, cash and cash equivalents could look relatively attractive.
For many investors, maintaining an allocation to cash and cash equivalents may continue to make sense with cash equivalents earning even more today than a year ago and being one of the better performing asset classes of 2018. Additionally, if one believes a recession is near or deflation may return, cash could serve you well. A fat pitch may be near at hand with multiple emerging markets down more than -15% from their highs and many individual stocks already in bearish territory. Consider discussing with your trusted advisor how income oriented cash equivalent liquidity may help your portfolio.
Endnotes
[i] My use of the name Johnny Cash references the American singer-songwriter that crafted lyrics for the humble everyman, the ordinary individual, and as such, also references the humbleness, commonality, ubiquity, and seeming ordinariness of cash, T-Bills, money markets, and very short-term bond accounts that compete with money markets.
[ii] Cash Equivalents are money market funds, demand deposit bank accounts, and marketable securities, commercial paper, Treasury bills and government bonds with a maturity date of three months or less.
Michael Ashley Schulman, CFA
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Disclosure: The views and opinions expressed are those of Michael Ashley Schulman, CFA and are subject to change without notice. The views and opinions referenced are as of the date of initial publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Forward-looking statements cannot be guaranteed; neither can backward-looking nor current-looking statements. This material is provided for informational purposes only and does not constitute an offer or solicitation to purchase or sell any security or commodity or invest in any specific strategy. It is not intended as investment advice and does not take into account each person’s or investor’s unique circumstances. Information has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Past performance is no guarantee of future results.
