Larry Fink, the CEO of BlackRock and hence probably the world’s most powerful investor, announced a critical change of direction earlier this week. “You could pause and earn money. You can afford the wait,” he pointed out in interviews following his company’s results.
Cash, meaning three-month Treasury bills, one of the world’s most boring investments, is back. As of today it is yielding more than 2 per cent for the first time since the summer of 2008. And that means, according to Mr. Fink, that if you want to sit out the equity market, you can do so and still make a little money.
This is a change of heart for Mr. Fink, who back at the beginning of the year in Davos was warning against the dangers of staying in cash. But the rise in cash yields has been swift and dramatic. Less than three years ago, T-bills’ yield was negative and there was no point in holding them. Whatever the Federal Reserve wants to do, the money market has decided on a swift normalisation in shorter-term rates over the past year.
We should not go overboard. Compared with headline inflation (currently boosted by the recent rise in oil prices), three-month T-bills still have a negative yield, as has been true for most of the past decade. Holding cash still does not look like the way to accumulate value for the long term. It seldom is.
But the key to Mr. Fink’s new-found enthusiasm for cash (and don’t worry, BlackRock has money market funds so should still generate a fee), is that cash yields once more exceed dividend yields on the S&P 500 (.SPX).
As recently as last September, S&P stocks yielded a full percentage point more, on average, than cash. They had yielded more than T-bills without a break since 2008. In 2009, as stock valuations hit rock bottom and the Fed desperately resorted to QE, stocks yielded almost 4 percentage points more than cash — a differential that made it almost pointless to hold cash.
This decade when equities paid more than stocks has looked truly anomalous. Ever since the 1950s, as wartime financial repression came to an end, it has been taken almost as a given that cash needs to offer a higher yield than equities, because of its lack of growth potential. they did not. Cash yields briefly overtook S&P yields on two occasions during Alan Greenspan’s long tenure at the Fed, but the decade-long period in which the central bank virtually paid investors to hold equities in a time of peace is without precedent.
This is a big deal. Conservative investors who wanted to take a “pause” from the equity market, to use Mr. Fink’s phrase, can now do so and still receive a 2 per cent yield for their trouble. That makes it a much easier step to take.
To be clear, U.S. equities still look very good value compared to cash by historical standards. The fact that cash yields very slightly more than equities would not in normal circumstances be a signal to sell equities. But to the extent that the post-crisis rally has depended on low yields on bonds and cash, that support is now being removed in a meaningful way — even if the continued aggressive asset purchase programs in the EU and Japan mean that stocks still have plenty of central bank support.
The money market is dictating a tightening of conditions, with the rise in the T-bill yield over the past two years, equivalent to 2 percentage points, slightly exceeding rises in the Fed Funds rate (1.75 percentage points).
Within equities, the main impact of higher-yielding cash so far has been to destroy the “hunt for yield” trade which for years had allowed companies with high and growing dividend yields to outperform the rest of the market. From the beginning of 2008 until the bond market peaked in the aftermath of the Brexit referendum two years ago, S&P’s “Dividend Aristocrats” index outperformed the S&P 500 as a whole by more than 40 percentage points.
The dividend-payers have since underperformed the market by 12 per cent, but there is room for this trade, which is accentuated by the enthusiasm for technology and the “Fang” stocks, to go much further.
Higher-yielding cash does not just make it easier to sit out of the market. It also detracts from the appeal of stocks, as it tightens financial conditions, making profits harder to come by.
Equity investors, judging by the latest BofA Merrill Lynch survey of investors, are worried about excessive corporate leverage (although credit investors conspicuously do not share their concern).
So this does indeed look like an important juncture. Money market rates have been pushed to a point where they are beginning to hurt.
What matters most now is whether this prompts a retreat by the Fed, perhaps scared by the flattening yield curve. Or whether it leads to a broader retreat from pricey stock markets.
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