We’re probably in ad nauseam territory by now when it comes to the “cash as a viable asset class” narrative. Indeed, we’re probably in the realm of stating the obvious.
After all, what’s not to like about cash in 2023? Riskless US government paper yields 5% or better, and you can get 4% or more in FDIC-insured savings products.
Elon Musk likes the idea. T-bills, the centibillionaire inventor-turned political instigator said this month, are a “no-brainer.” Musk is running an extreme version of the “billionaire barbell.” He personifies “long high-growth, speculative, high-multiple tech,” and he’s also long USD cash yielding 5%.
What’s interesting in 2023 is that adjusted for inflation and relative to returns on equities, cash is actually less compelling than it was five years ago, when Jerome Powell was gingerly, if stubbornly, raising rates against the backdrop of Donald Trump’s trade war.
2018 was the only year in at least a quarter century during which cash was the best-performing asset class. This year, it’s been trumped by equities.
Of course, that’s a naive assessment. Fitch (and SVB) aside, there’s no risk involved with USD cash. Equities carry considerable risk.
Still, when we think about the risk-reward calculus around equities versus cash and fixed income, we shouldn’t get so lost in risk-adjusted performance measures, models, ratios and metrics that we give short shrift to the simple, if often uncomfortable, reality that there’s no limit on how much investors are “allowed” to pay for every dollar of corporate earnings (or no earnings at all, for that matter). Being smug about elevated equity multiples (or a falling ERP) doesn’t make you look smart if you’re a bear in a rally — it makes you look bitter.
The “risks” with cash are inflation and the opportunity cost of putting your money to work in something other than T-bills. It’s tempting to pat yourself on the back this year for being the (very stable) genius who’s earning 5% risk free on “sleep-well-at-night” cash in what’s now a 3% headline inflation environment. But the truth is, the opportunity cost vis-à-vis equities has been very, very high in 2023.
Already, this is a record year for global money market fund inflows. $925 billion YTD eclipses 2020. Equities, by contrast, have taken in just $83.3 billion on net. US-focused equity ETFs and mutual funds have seen a net $13.2 billion in outflows this year. And yet, the S&P has returned 15%.
Amid this month’s modest stock swoon and accompanying reals-led bond rout, I’ve read a lot of ostensibly smart, overtly haughty analysis which can be roughly summarized as follows. “Well, real rates are the highest in decades, and stocks are trading at 20x, so the risk-reward clearly favors cash and especially bonds given the potential for price appreciation in the latter.”
Note: You could’ve made a similar argument in January — or ~35% ago on the Nasdaq. And while cash is just cash, it’s important not to lose track of the fact that the reason bonds are now “more attractive than ever” is because they keep selling off. And they’ve been anything but docile.
Certainly, bonds are a better value proposition than they’ve been in a very long time, and it’s entirely plausible to suggest a huge rally is just one negative NFP headline away. At the same time, if the Fed clings to terminal and inflation continues to moderate, real returns on cash will seem handsome indeed.
But betting on bonds could be akin to catching falling knives, and assuming stocks can’t run higher in the face of rising real yields is to ignore the possibility that reals are rising because the market is in the process of upgrading its view on the long-term prospects for the US economy. Assuming you take the idea of r-star seriously in the first place, what does it say about an economy when it takes higher real rates to brake growth? And what does that say about the prospects for corporate earnings?
