Sweeping Rock and Sky, Joshua Tree, by Michael Ashley

Overall, we are positive on 2018.  Nonetheless, I believe cash has finally found a home again.

  • Cash is once again a viable investment option – rather than just a safety play
  • The monetary unwind of central banks will shift investors away from risk
  • Look for huge money flows into Cash and Cash Equivalents as well as short-term bond funds

Cash returns have more than sextupled but risk is the same: 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[i].

  • Three years ago, on 12/31/14, 1 month LIBOR [an internationally recognized short-term interest rate benchmark] was 17 basis points (0.17%) and 3 month LIBOR was 26 basis points (0.26%)
  • As of 12/28/17, 1 month LIBOR is up over nine times to 157 basis points (1.57%) and 3 month LIBOR is up over 6 times to 169 basis points (1.69%)

As investors see higher short-term rates, cash will once again become a viable investment option – rather than just a safety play – and we will see huge money flows into Cash and Cash Equivalents as well as short-term bond funds. Don’t underestimate this trend that I call the march towards Johnny Cash [ii].

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.

  • 2018 headlines will declare the viability of earning near 2% with cash and relatively safe short term funds

Monetary unwind will edge investors away from risk: Following the great financial crisis of 2008, the Fed drove people towards riskier assets by driving short-term interest rates (specifically the Fed Funds rate) to zero and buying $3 trillion of bonds; this was commonly known as quantitative easing (QE).  The European Central Bank (ECB) and the Bank of Japan (BoJ) followed a similar path and drove rates negative with their QE in their respective spheres.  The unwind of financial easing (also known as quantitative tightening (QT)), first by the Fed and eventually by the ECB, will drive people away from risk. In other words, as central banks become less supportive of risk, some investors will pare back their equity and debt exposure and place that allocation in Cash and Cash Equivalents. Others will invest in short duration credit (i.e., short-term municipals, bank notes, corporate bonds, mortgages, and high yield) and floaters (i.e., floating rate bonds like well-structured SBAs/ARMs, floating rate corporates based off LIBOR, and even some floating rate agencies).

Johnny Cash at 1.5% or higher looks pretty good: Johnny Cash and short-duration funds can finally provide a good risk adjusted area for investors to hang out.  In June 2016, an investor had to go out 19 years on the U.S. government Treasury yield curve to earn 2%.  Now, as of 12/28/17, 5-year Treasuries yield 2.24%, and the 2-year 1.91%.  Thus, one needs approximately sixteen years less to earn a similar annualized return. After years of earning close to zero on cash, earning north of 1.5% will psychologically feel pretty good.

The allocation pie may change: For advisors, money managers, columnists, and journalists that for several years have been touting the 70/30, 60/40, 50/50, or other similarly ratio portfolio, their pie charts may need to slice in a notable allocation for Johnny Cash and short-duration. In typical parlance, a 70/30 balanced portfolio is allocated 70% to equities and 30% to debt; similarly, a 60/40 balanced portfolio is 60% equities and 40% debt.  However, this common parlance leaves out a cash allocation which can be very worthwhile.

            Graph 1: Sample Equity and Debt allocation pies

   

 

Maybe the new mantras will be 60/25/15, 55/35/10, or 40/40/20.

            Graph 2: Sample Equity, Debt, and Cash allocation pies

   

 

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, either access to cash or access to margin will be immensely useful for the opportunity.  But if risk dials up in a pull back, as it often does, margin allowance may be constrained, but, Johnny Cash will be there.

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[i] 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.

[ii] Johnny Cash conjures images of the American singer-songwriter – with cross-over appeal for most music genres – that crafted lyrics for the humble everyman, the ordinary individual.  As such, the humbleness, commonality, ubiquity, and seeming ordinariness of cash applies here.

 

The views and opinions expressed are those of Hollencrest Capital Management and are subject to change without notice. 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 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.