King Cash is making a grand comeback.
At the end of a volatile year, and on the cusp of the 10th anniversary of the bull market in stocks, investors are waking up to the reality that the good times will not last forever. Various strategists at firms from Goldman Sachs to Bank of America Merrill Lynch expect volatility to persist in 2019 such that stocks will produce lower risk-adjusted returns.
That’s where cash comes in. It’s an asset with almost no volatility, and it’s becoming more attractive as short-term interest rates rise. It’s also becoming more alluring as a cushion against wipeouts in the equity market, with cash stockpiles acting as dry powder for dip-buyers.
“When cash is earning you somewhere in the 2% to 2.5% range, it should be on the table,” said Andrea DiCenso, a co-portfolio manager at Loomis Sayles, during a recent press briefing in New York.
“In our multi-asset discussions, this is the first year in any year I can remember that we actively are saying ‘is an allocation to cash the right thing to do at this point?'”
The colorful quilt of asset-class returns below illustrates why portfolio managers like DiCenso have rightly shunned cash for the last couple of years. Represented in deep purple, the graphic shows that cash underperformed fixed income, the S&P 500, and the Russell 2000 for much of the post-crisis era.
This expansion has also been marked by a hunt for returns that’s pushed investors into assets riskier than government bonds, which have provided beefier yields, in addition to being comparatively safe. Investors adopted a “there is no alternative” mindset to stocks in their quest for returns.
“For most of this cycle, stocks enjoyed a lack of compelling asset class alternatives (bonds had elevated price risk, cash yields hit rock bottom),” said Savita Subramanian, the head of US equity and quant strategy at Bank of America Merrill Lynch.
“But cash is now competitive and will likely grow more so.”
Subramanian noted that the 3-month Treasury bill already yields more than 60% of stocks on the S&P 500.
The big challenge for investors in 2019
Subramanian forecasts that the S&P 500 will peak near 3,000 next year. Many of her colleagues aren’t as specific in their 2019 outlooks, but most of them expect the ongoing volatility in markets to continue.
“In an environment of rising equity market risks, single-digit stock returns, and improving cash returns, we recommend investors reduce portfolio risk by raising their allocation to cash relative to stocks,” David Kostin, the chief US equity strategist at Goldman Sachs, said in his 2019 outlook note.
Kostin said the biggest investment challenge for portfolio managers in 2019 is that earnings and economic growth will slow down, but no one will be able to pinpoint the terminus of this cycle. Put differently, the directions of earnings and economic growth will be positive, but the rates of change will slow at in an unpredictable way.
Kostin recommends that investors start taking defensive positions ahead of the slowdowns. Practically, he advised an underweight position in cyclical sectors of the stock market that benefit when the economy is improving. And, piling on cash would also work as a defensive strategy for investors.
He further observed that households, mutual funds, pension funds, and foreign investors own 12% in cash as a share of their total assets — the lowest level in 30 years.
This trend was corroborated by a survey of 500 institutional investors conducted by Natixis Investment Managers, which found that merely 5% of portfolios consisted of cash.
David Lafferty, the chief market strategist at Natixis, said there are practical reasons why these massive investors have been reluctant to hold cash, including boards and pension-plan consultants that push managers into owning higher-yielding assets.
“I don’t think we’re ever going to see pension plans say ‘we’re backing up the truck on cash,'” Lafferty said at his firm’s briefing.
“That’s politically not something they can do. But I do think when they start to put it into their capital market assumptions — to [Loomis Sayles’s Andrea DiCenso’s] point — it doesn’t fall off the bottom of the page anymore. It’s part of the conversation, even if they don’t want to say it out loud.”