Investing is a matter of risk and profit, but these days it is about risk and less about profit. Some risks are not only poorly profitable, but more expensive than holding money in the safest ways. The additional return that can be earned today on cash by buying risky junk bonds is the lowest it has ever been, except during the credit bubble of 2007, according to data recorded since 1986.
● Economists warn: the interest rate in the US may rise even beyond 5%
● Growth in January’s US employment data surprised economists. Why are their forecasts so often wrong?
● The author of the bestseller “The Black Swan” warns: “The Disneyland in the markets is over”
Wall Street’s standard, if flawed, valuation metric shows that the risk-adjusted risk premium of holding stocks instead of cash is the smallest since the dot-com bubble burst.
So why take the risk and the hassle of investing, when lovable and safe money funds or Treasury bonds are so attractive? There are two basic answers. One is that investors do not expect cash to remain so attractive, and want to lock in future returns. The second is that after a decade Where cash was junk with zero return, there are few who think of cash as more than a temporary place to park the money.
Changing thinking: you don’t have to abandon cash
That thinking needs to stop, at least for now. There is little profit in abandoning cash in favor of other areas.
The Federal Reserve pays 4.55% to funds in its reverse repurchase vehicles (reverse repurchase vehicles) accounts, as part of an effort to absorb cash from the economy and keep interest rates high. This interest rate is higher than the yield on safe AA-rated bonds, such as Apple’s or Berkshire Hathaway’s. These companies are among the most solid – but investing in them still involves more risk than holding cash at the Federal Reserve or in short-term bonds of the Ministry of Finance (T-bills), where the yield for three months is 4.54%.
Among other things, this can be explained by investors’ expectations of interest rate cuts by the Federal Reserve starting in the summer, expectations that increased on Wednesday last week, when Fed Chairman Jerome Powell did not express strong reservations about the recent rally. The result of this was an inverted yield curve, with yields on Long-term bonds are lower than yields on shorter-term bonds and cash.
But we’ve already had inverted yield curves many times before (before every recession in the last 60 years, actually). Since the Merrill Lynch ICE Index began in 1988, there has never been a single instance in which cash has yielded greater returns than safe AA-rated bonds. Investors have always demanded a high premium over bonds for the added risk involved, more than offsetting the lower yield on long-term bonds during yield curve inversions.
The difference this time is that companies are taking loans for longer periods, which means that the inverted yield curve lowers their bond yield more than before. The additional yield they pay on top of treasury bonds, although it is higher than in many cases in the past, is still low, and is not enough to return the yields received from cash.
Stocks are more difficult to analyze, because they do not guarantee a fixed coupon like bonds. The standard way to extract the future premium they offer is to compare cash or bonds to the earnings yield on stocks, divided by price, or the inverse of the price-to-earnings ratio. .
The yield on earnings is currently 1% above the three-month Treasury bond yield, an improbably low level given the risk involved in holding stocks. Again, part of this is because investors are betting that the Fed will move to lower interest rates later this year, which helps stocks.
This is partly because the measurement method is flawed. But a lot of that is because stocks are still expensive relative to interest rates, even after last year’s big selloff.
One way to try to fix the problems is to compare the earnings yield on stocks with the real ten-year yield on Treasury Inflation-Protected Bonds (TIPS). Here stocks are offering 4.5% more than inflation-protected bonds, which doesn’t sound so bad. But it is: it’s the worst excess return since 2007.
So true, just because risk assets are expensive compared to cash doesn’t mean that cash will perform exceptionally well. But think about the gains versus the risks you are taking. Risk-free cash – if you ignore defaults because of the debt ceiling – looks very attractive.