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Roger Aliaga-Diaz, regional chief economist, Americas, and head of portfolio construction at The Vanguard Group Inc., sees investors moving to higher-yield cash accounts as a global trend, but says that might not be the best option.
He recently spoke with Globe Advisor about his market outlook for this year.
What’s the lure of high-yield, cash accounts?
With this level of interest rates, people are questioning whether they need to take as much risk and go into equities.
So, we have seen portfolios tilting more toward fixed income and cash because they can get that yield. Before, some people may have gone out of their risk curve to get the yield. So, maybe what we’re seeing is people dialling back to their true risk profile.
The problem with cash is even at these yields, it may not be able to keep up with inflation. The inflation numbers we’re seeing now, hopefully, they’re going to start coming down. We may start seeing the interest rates become positive in real terms. But for the time being, even those yields are not keeping up with inflation.
What if rising interest rates and inflation continues longer than expected?
That’s definitely a risk. Unfortunately, the science of portfolio construction is uncertain, so you have to account for all the possible scenarios. What I wouldn’t recommend is designing a portfolio for one particular scenario.
You have to invest for the middle path, which is why diversification is so important. So, don’t be concentrated in cash. Don’t be concentrated in long-term bonds, either. That’s why I encourage this broad diversification across the entire given curve.
If we see another breakout of inflation – not very likely, but it could happen due to political events or energy shocks – then at least there is some cushion with broad diversification. But central banks have been so aggressive with tightening that it looks like inflation slowly and gradually will continue to march down. So, sitting in cash may not be the best option.
What is your outlook for this year?
Inflation will come down, but it will come at a cost with a global recession.
It will be a monetary-induced recession but we haven’t seen the full impact of it yet on the economy. We’ve seen it in housing and, in some sense, with manufacturing, but there is a little more to come. We’ll see a recession toward the second half of the year.
Furthermore, we think we’re entering a period of positive real interest rates, which has not been the case for 10 years.
And that means thinking when central banks get over the tightening cycle, how much will they have to start cutting down, and how far are they going to get. Maybe they don’t need to get back to 2.5 per cent. Perhaps it’s a higher interest rate, which is good news for investors in money markets, cash and bonds.
This interview has been edited and condensed.
- Deanne Gage, Globe Advisor Reporter
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