When everything else is faltering, cash becomes king.
With stocks, bonds and commodities all in an unusual, simultaneous slump this year, cash and cash equivalents stand to best them all as a top-performing financial asset.
The returns offered by cash proxies such as guaranteed investment certificates and short-term government bonds, while modest, are at least positive.
Long-term Canadian bonds, on the other hand, have retreated as yields have increased, while the S&P/TSX Composite Index is down 8 per cent this year.
Also in negative territory: equities, corporate debt and government bond indexes in many global markets, as well as a range of commodities from crude oil to gold and copper.
The global downturn in financial assets this year has produced a rare top ranking for cash.
“Cash to me is a legitimate asset class,” said John Zechner, president of Toronto-based wealth management company J. Zechner Associates. “I’ve been through too many cycles when I was kicking myself for not selling enough when valuations were extended and things were slowing down.”
Over the course of the bull run that began when markets bottomed out in 2009, rock-bottom interest rates and meagre bond yields pushed income investors into the stock market as the only place to earn a decent return. Cash was seen as dead money.
This year, however, cash has proved its value as a hedge against stock volatility. Cash returns as approximated by Canada three-month treasury bills have exceeded Canadian equity returns by about 10 percentage points.
In the United States, cash proxies have also outperformed the S&P 500, which has been driven into negative territory on the year by the recent sell-off.
Going into next year, muted expectations for equity performance, combined with rising interest rates, have shifted the prospects for relative performance between asset classes.
“Cash will represent a competitive asset class to stocks for the first time in many years,” said David Kostin, chief U.S. equity strategist at Goldman Sachs, in his 2019 outlook.
But U.S. investors are not positioned for a late-cycle market, when equity returns tend to become less reliable and more volatile, Mr. Kostin said.
At the end of the second quarter, households, mutual funds, foreign investors and pension funds with money in the U.S. market had a 44-per-cent weighting in equities – the highest level of equity exposure since the tech bubble in the late 1990s, Mr. Kostin said.
At the same time, those investors had cash allocations of 12 per cent, which is the lowest in 30 years.
“We recommend mixed-asset investors recalibrate their portfolios by reducing equity holdings and lifting cash allocations,” Mr. Kostin said.
Goldman Sachs is projecting that the S&P 500 will generate a modest, single-digit return next year, while three-month T-bills should see a total return of 3 per cent.
In Canada, returns on short-term investments have risen in recent months as the Bank of Canada has hiked policy rates. One-year GICs now offer as much as 3 per cent.
“You’re not going to retire rich on that, but cash is at least going to give you your money back, with a bit of return,” said Ian de Verteuil, head of portfolio strategy for CIBC World Markets.
Expectations for higher short-term rates in Canada have fallen back of late, however, as the collapse of Alberta crude prices has clouded the domestic economic outlook. But nominal cash returns will at least be guaranteed to be positive and with next to no volatility.
“Holding cash provides some downside protection and defensiveness,” said Colin Stewart, chief executive and portfolio manager at JC Clark Ltd. in Toronto. “It can be useful in periods of uncertainty. And now would be one of those times.”
In JC Clark’s long-only funds, cash weightings sit between 10 per cent and 30 per cent, Mr. Stewart said.
“I would not want to suggest that we or anyone else have a long-term investment strategy of holding 30-per-cent cash. That’s just not a smart idea,” he said.
Inflation erodes the value of cash, while equities have generally proven to generate superior returns over the long term.
Tim Shufelt