Thursday, March 22, 2018

Is cash no longer trash?

There is a new meme going around that cash is no longer trash - the rising short rates make cash a real alternative to a over-valued equities and bonds. Cash is now a viable alternative with rate moving higher. The 3-month bill rate has moved up to 1.75 percent from .16 bps at the end of 2015. The impact on money funds is significant even if inflation is close to 2%. There are good alternative but they will have to compete against cash for investor attention.

  • An alternative to bonds - The flatter curve makes cash not trash. The differential between the 10-year and 1-year Treasury is inside 100 bps. There is less term premium with holding longer duration.
  • An alternative to dividend yield - The higher cash yields make cash not trash. The cash yield at one year is similar to the dividend yield (1.80%) on the stock market (SPY). The current earnings yield is 3.95, higher than one-year Treasuries but at a lower spread than over the last few years. 
  • An alternative to international bonds - Positive yields make cash not trash. Euro area yields for one year are still negative at -.68%.
  • Overvalued bonds and equities make cash not trash. There is still downside risk as measured by tail exposures in options for both stocks and bonds. CAPE P/E ratios are high relative to history and bond risk premiums are still close to zero.
Inflation makes cash still trash. Given the US inflation rate is close to 2%, the real rate is still at best zero to slightly negative. These are better than recent numbers but nothing that should get investors happy.

Hedge funds can make cash trash. In the current environment of falling correlation within stock indices, higher volatility, and more market dislocations, there is the opportunity for greater hedge fund returns. For CTAs, which hold most non-margin money in cash, rising rates are a nice tailwind, albeit rising rates has not always been a CTA friend.

Unfortunately, rising cash rates also means that credit is tightening. Corporate spreads are widening. This does not immediately translate to higher risk, but the credit environment is not changing for the better. 

Nevertheless, cash is now a viable investment option to marginal investment strategies.

No comments: