…At first sight, the reasoning to move to cash may look intriguing [as] markets have rallied a lot over the last year, are at all-time highs, and look relatively expensive but, in an ultra-low-rates world, cash just isn’t a good choice. [Here’s what to do instead.]
- Based on current consensus estimates, the index trades for around 25 times 2021’s earnings, and for around 22 times 2022’s earnings [which] both represent above-average valuations, as the index has mostly been valued at a mid-to-high teens earnings multiple in the past.
- Looking at that singular fact, one may conclude that the market is overvalued and that it would thus be prudent to move to cash to wait for a better entry price…This, however, is not what we conclude.
Factoring in additional data and not looking at equity market valuations in a vacuum, we believe that there are way better alternatives than going into cash.
- …We see that, despite the fact that the S&P 500 earnings yield isn’t especially high, it is still way higher than the yield one can get from treasuries. Based on estimates for 2022, the broad market offers an earnings yield of 4.5%, which is almost three times as high as the yield one can get from treasuries right now.
- When we also add in that the S&P 500 earnings should grow over the long term, which will increase the earnings yield over the years, whereas bonds don’t have any built-in growth, then equity markets do still look a lot better than treasuries.
- The same holds true for the comparison between equity markets and money market funds and other cash-like investments, which are all offering returns that are way lower than what one can reasonably expect from equities.
The next issue with holding a large cash allocation is inflation. Inflation has not been overly high over the last decade, but there are several data points that suggest that inflation may be more prominent going forward…
- The CPI rose at the fastest pace in almost a decade in March, at a rate of 0.6% on a month-to-month basis.
- The trailing 12-month percent change in March also was way higher than the 2% targeted by the Fed, at 2.6%.
- Drivers for higher inflation included energy costs, which rose considerably over the last year due to the rise in oil and gas prices, but also other items, including wage inflation. Since these factors will likely remain in place, it is not a big surprise to see that inflation expectations are way ahead of 2% right now…
The current consensus sees prices rise by a little more than 3% a year. This is especially telling when one accounts for the fact that asset inflation is oftentimes not fully captured in CPI statistics…Home prices have, for example, risen by 11% over the last year, which isn’t really inflected in CPI statistics, thus what one could describe as the “real” loss of purchasing power may be even higher than 3% a year. Even when we just go with 3% a year, however, it seems quite clear that cash and most cash-like alternatives will be money-losing investments in the long run. If you invest your money into a CD with a rate of 0.2%, while inflation is eating away 3% of your purchasing power, you will have lost 10% of your net worth (in real terms) after just 4 years. Over longer periods of time, that effect compounds further, and real losses will grow even higher. Compared to that, even owning the S&P 500 index at all-time highs seems like a good idea, as the earnings yield on the index is higher than expected inflation rates, while earnings of most companies should continue to grow in the long run.
There are, however, better investments than owning the broad market as a whole, we believe. After all, valuations do seem relatively high on average, while at least some of the companies in the index seem quite vulnerable still and won’t get back to pre-crisis levels of profitability in the near term – cruise lines, airlines, etc. come to mind.
Everyone should have a smallish cash position that is sufficient to pay for one’s expenses for a couple of months, but putting those long-term investments towards cash is, as explained above, likely a money-losing strategy due to inflation rates being way higher than returns on cash and equivalents.
Yes, markets have run up quite a lot over the last year, and they are not at all inexpensive but for long-term investors, cash is still not a good choice. Returns on cash investments are abysmal, and inflation will lead to negative real returns, especially since inflationary pressures are rising.
In an ultra-low-rates world, cash just isn’t a good choice…Since “Cash is Trash”, we do not believe that moving to a very high cash allocation will be a good choice. We believe that remaining invested but avoiding overvalued hype stocks – and, instead buying undervalued quality picks – will pay off in the future, as it has in the past.
Editor’s Note: The original article by Jonathan Weber has been edited ([ ]) and abridged (…) above for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor. Also note that this complete paragraph must be included in any re-posting to avoid copyright infringement.
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