Suddenly, cash is the hottest asset class in the world.
The coronavirus pandemic catalyzed an all-consuming selloff across virtually every type of financial asset, including those that normally serve as safe havens, such as gold and government bonds.
Fear and panic were primarily to blame for the scramble to liquidate anything and everything in a bid to raise cash.
But it also didn’t help that investors were heavily exposed to the stock market before the correction, by several measures. One of the strongest and longest bull markets in history acted as a powerful magnet for institutional and retail money alike.
“Everybody was pretty aggressively invested,” said Colin Stewart, CEO of JC Clark Ltd. in Toronto. “There wasn't a ton of cash on the sidelines a few months ago.”
On Friday, the market nosedive resumed with the S&P/TSX Composite Index falling by 5.1 per cent and the S&P 500 by 3.4 per cent, after a huge rebound earlier in the week that saw the two benchmarks rise by 19.1 per cent and 17.6 per cent, respectively, over three straight days of gains. From February’s peak, the losses in Canadian stocks now sit at 29.3 per cent, and 24.9 per cent for the S&P 500.
The few who were sitting on decent cash stockpiles before the plunge are now grateful for the dry powder. Not only did it cushion some of the blow of the crash, that cash will sow the seeds for the big gains that tend to be born of bear markets when they finally bottom for good.
“People who went into ‘08-‘09 with cash were in a great position to allocate capital intelligently and buy some great assets at really cheap prices,” Mr. Stewart said. “I'm sure this time will be no different.”
Look no further than to Warren Buffett as evidence of the potential value of cash.
Mr. Buffett is a believer in what’s known as the “optionality” of cash. Like a call option, cash gives its holder the right but not the obligation to buy an asset. But unlike the financial contract, cash has no strike price, no expiry, and can be use for any asset class.
The Berkshire Hathaway CEO famously made a killing as a buyer through the global financial crisis, sinking money into big U.S. banks trading at distressed valuations, such as Goldman Sachs and Bank of America.
In the years since, Berkshire built up an enormous cash hoard, totalling US$128-billion as of the end of 2019.
On a lesser scale, JC Clark’s Mr. Stewart said he’s dipping a toe in stocks weakened by the global health crisis, deploying some of the 30-per-cent cash weighting held in most of the firm’s funds prior to the selloff.
He’s focusing on companies with contractual revenues in consumer staples, real estate and renewable power sectors. “Even if the economy is slow to recover, these businesses still have revenues, unlike a cruise line or a movie theatre company,” he said.
Wealth management company J. Zechner Associates is directing some of its cash reserves at Canadian companies with resilient earnings and good dividend payouts, such as telecoms, pipelines and financials.
“If I can buy a Canadian bank stock at a 7- or even 8-per-cent yield, I’ll take some of the capital risk,” said John Zechner, the firm’s president.
The average investor, on the other hand, went into this bear market with relatively little cash. In the United States, the average equity weighting sat at 66 per cent in February, while cash reserves sat below 15 per cent, according to an asset allocation survey by the American Association of Individual Investors. The long-term average cash weighting is around 23 per cent.
It’s rare for investors to be that heavily exposed to stocks and that light on cash. So when the pandemic gained a foothold in Europe and North America, many investors rushed to reduce their holdings of riskier assets.
Since March 9, when market volatility first reached panic-level proportions, nearly every asset class is in negative territory: global stocks, investment grade debt, high yield debt, 10-year government bonds in the U.S. and Canada, gold bullion, base metals, and crude oil futures.
“Investors, companies and people need cash because the U.S. economy is being shut down for an unknown period of time,” Bank of America analysts said in a report.
Sooner or later, many investors will have to decide when and how to redeploy cash built up over the great liquidation.
Mr. Stewart said he is taking a gradual approach. “We’re probably going to go slow over the next few months. We’re not trying to pick the bottom.”