Column: Dethroned cash can still rule in stressful times

Dollar, Euro and Pound banknotes are seen in this picture illustration
Dollar, Euro and Pound banknotes are seen in this picture illustration taken April 28, 2017. REUTERS/Dado Ruvic/Illustration

September 29, 2021

By Mike Dolan

LONDON (Reuters) – Cash may no longer be king, but it can still rule sometimes.

With central bank interest rates at historic lows for much of the past decade, most long-term investors have found “cash is trash”, quickly burning a hole in their returns.

Meanwhile, policy rates of the G4 have been floored to near zero or below since the coronavirus crisis hit, scuppering attempts at some monetary normalisation.

As a bottlenecked pandemic recovery stokes inflation and inflation expectations, transitory or not, those cash rates have all sunk more deeply negative in real terms, making cash a lousy place to be in any size over the medium term.

And yet asset managers have not completely dispensed with some cash under the portfolio floorboards as it still offers flexibility and liquidity to manoeuvre in choppy waters.

BlackRock strategists, for example, retain a ‘neutral’ tactical weight in cash over a 6-12 month view to offset their moderately ‘pro-risk’ view – keeping some to “potentially further add to risk assets on any market turbulence.”

And this is where boring old loss-making cash still has a role, even if only temporarily in the short term.

The case for cash is not about its return, it is about how you avoid losing your shirt on everything else, including traditional havens like government bonds.

Robeco’s annual five-year investment outlook this week is that with projected annualised inflation in dollar terms from 2022 to 2026 estimated at 2.25%, their expected dollar cash return of 1.0% gives an annualised real loss of some 1.25%.

That negative real outlook plays out for top-rated government bonds too, leaving Robeco’s only inflation-busting projected returns through 2026 in equity, real estate, commodities, junk bonds and local emerging market debt.

As markets rethink central bank rate hike horizons into next year, historically expensive government and corporate bond prices and the most-stretched equity prices may face a hefty re-pricing and significant pullback.

Top-rated bonds have often been the “go to” buffer against stock market corrections. But many investors feel their extreme sub-zero real yields and elevated prices mean they embed one-way risk that may well correlate or even drive any equity shakeout.

Less volatile cash is simply less risky.

CASH REGENCY

Morgan Stanley’s multi-asset strategist Andrew Sheets says cash returns relatively little because it has, by definition, the lowest risk premium. And when riskier assets face turbulence – as he thinks they look set to do in the final quarter and into 2022 – cash still functions from month to month.

In short bursts, cash returns relatively more with less risk. Sheets says that since 1959, the probability of U.S. cash holdings outperforming the S&P500 in any month is 40% and one-in-three over any 6 month horizon.

“Investors should hold an above-average allocation to cash,” he told clients, adding: “This argument is strongest versus assets in the U.S. and Emerging Markets and weaker for those in Europe and Japan.”

“The flipside of cash being a boring, low-return asset is that it has an attractive risk profile which can help within portfolios as a buffer against market volatility.”

Using estimates over the past 10 years of so-called “cVaR”, essentially the average of monthly losses beyond assumed ‘Value at Risk’ measures embedded in implied volatility gauges, cash shines with -0.1% compared to more than 9% for equities, 1.7% for Treasuries and 4.9% for high grade corporate bonds.

The implications of investors stashing higher cash than usual are significant, potentially amplifying broader market pullbacks into yearend and likely biasing many to the dollar.

Bank of America’s monthly fund manager survey in late August had cash holdings at 4.2%, well below the 10-year average. But, perhaps with the end of the third quarter in sight, flows tracked by BoA saw the first weekly outflow from global equity funds last week and almost $40 billion flooding into cash funds.

As markets wobble and the dollar builds up steam, it could well force a rethink of increasingly hawkish central bank signalling about tightening ultra-loose monetary policy.

And if the dollar were to take off more sharply, that could itself act as a brake on the sort of commodity price surges creating so much inflation angst among monetary policymakers.

A circular stabiliser maybe, but not without a potentially restive period where cash once again wears the crown.

(by Mike Dolan, Twitter: @reutersMikeD; editing by Alexander Smith)