Amerant of Interest

We have seen that clients have a tendency to stay short, in cash and T-bills, rather than take advantage of higher interest rates to extend duration and buy risk assets
The inverted yield curve makes this trade even more appealing, as the longer Treasury rates are below short-term ones… most clients do not see the attractiveness of buying longer-dated bonds at similar rates to T-bills
Over the long term, however, cash has rarely provided the best returns compared to longer duration fixed income, high yield, or equities

We sometimes feel like a broken record when we encourage clients to consider alternatives to cash and Treasury bills and consider adding longer term corporate bonds to their portfolios. Since last year, we have strongly advocated that clients stop parking excess cash in T-bills and add to risk assets. We still see that many clients prefer to park their excess liquidity for a 5%+ yield on short-term T-bills, reflecting lingering concerns about the direction of the economy and rates, while also preserving the optionality to invest in risk assets at a later time.

Maintaining Liquidity Makes Sense
While we acknowledge that cash does have a place in every portfolio, we see that many clients are still maintain a lot of extra cash as they realize that the return on cash is higher than it has been in many years. Of course, keeping a portion of a portfolio in cash makes sense for clients with upcoming liquidity needs. Cash will be there when you need it, and it will not lose nominal value, even though the purchasing power of cash erodes over time due to inflation.

Rising Rates Sting, But the Pain Dissipates Over Time
We also note that, in the period of rising rates, such as the one we have just experienced, cash did outperform longer-duration fixed income. Take a look at the chart below. This compares the total return of the Bloomberg Intermediate Aggregate bond index (investment grade Treasuries, corporates, and securitized bonds with less than 10 years to maturity) to an index of 1-3 month T-bills.

The above chart shows that simply holding cash would have been a better total return over the past three years, up 8% compared to a loss of -2% in intermediate bonds.

Time Heals All Wounds
Now, let’s look at the same chart since 2004. In this chart, the power of long-term fixed income investing becomes clear. In that period, owning longer term bonds would have outperformed T-bills by a wide margin. In short, the issue comes down to time and the power of compounding returns over the long term. Cahs rarely make sense over an extended time horizon, as the total return benefit from higher yields on corporate bonds compounds over the long term.

Risk Assets Do Even Better
Now, let’s consider the long-term performance of risk assets such as high yield bonds and equities.

In this case, the outperformance versus cash is compelling. In the past 20 years, holding cash would have generated cumulative returns of 33%. Owning high yield bonds would have generated returns of 360% over the same period while owning equities would have been a nearly 5x return.

Real Yields Are Attractive
Finally, we note that holding cash does not guard against the erosion of purchasing power from inflation. In our view, the Fed will ultimately be successful in getting inflation back down to the 2% range sometime in the next 12-18 months.

Once this is achieved, the Fed will begin to lower short-term rates, and the return on cash will likely revert to only a very small positive real rate. Clients that have a longer time horizon can lock in today’s attractive yields before the Fed begins lowering rates. To illustrate, we took a look at the difference between the core inflation rate (PCE) and the yield on corporate bonds. Since 2010, investors pricked up an average 1.28% over core inflation rate to be invested in corporate bonds. Today, the difference is 2.26%, nearly a full percentage point higher than the average.

We hate to sound like a broken record, but in this case, it deserves repeating. In our view, cash will likely not deliver the best returns over the long run, and for clients that have a long-term investment horizon, it is a good time to consider deploying excess liquidity into longer-dated bonds or equities.

Definitions, sources, and disclaimers

Definitions:

Gross Domestic Product (GDP): A comprehensive measure of U.S. economic activity. GDP is the value of the goods and services produced in the United States. The growth rate of GDP is the most popular indicator of the nation’s overall economic health. Source: Bureau of Economic Analysis (BEA).
GDPNow is not an official forecast of the Atlanta Fed. Rather, it is best viewed as a running estimate of real GDP growth based on available economic data for the current measured quarter. There are no subjective adjustments made to GDPNow—the estimate is based solely on the mathematical results of the model. In particular, it does not capture the impact of COVID-19 and social mobility beyond their impact on GDP source data and relevant economic reports that have already been released. It does not anticipate their impact on forthcoming economic reports beyond the standard internal dynamics of the model.
The Current Employment Statistics (CES) program produces detailed industry estimates of nonfarm employment, hours, and earnings of workers on payrolls. CES National Estimates produces data for the nation, and CES State and Metro Area produces estimates for all 50 States, the District of Columbia, Puerto Rico, the Virgin Islands, and about 450 metropolitan areas and divisions. Each month, CES surveys approximately 142,000 businesses and government agencies, representing approximately 689,000 individual worksites. Source: Bureau of Labor Statistics (BLS).
Initial Claims: An initial claim is a claim filed by an unemployed individual after a separation from an employer. The claimant requests a determination of basic eligibility for the UI program. When an initial claim is filed with a state, certain programmatic activities take place and these result in activity counts including the count of initial claims. The count of U.S. initial claims for unemployment insurance is a leading economic indicator because it is an indication of emerging labor market conditions in the country. However, these are weekly administrative data which are difficult to seasonally adjust, making the series subject to some volatility. Source: US Department of Labor (DOL).
The Consumer Price Index (CPI): Is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. Indexes are available for the U.S. and various geographic areas. Average price data for select utility, automotive fuel, and food items are also available. Source: Bureau of Labor Statistics (BLS).
The national unemployment rate: Perhaps the most widely known labor market indicator, this statistic reflects the number of unemployed people as a percentage of the labor force. Source: Bureau of Labor Statistics (BLS).
The number of people in the labor force. This measure is the sum of the employed and the unemployed. In other words, the labor force level is the number of people who are either working or actively seeking work.Source: Bureau of Labor Statistics (BLS).
Advance Monthly Sales for Retail and Food Services: Estimated monthly sales for retail and food services, adjusted and unadjusted for seasonal variations. Source: United States Census Bureau.
Federal Open Market Committee (FOMC): Responsible for implementing Open market Operations (OMOs)–the purchase and sale of securities in the open market by a central bank—which are a key tool used by the US Federal Reserve in the implementation of monetary policy. Source: Federal Reserve.
The Federal Funds Rate: Is the interest rate at which depository institutions trade federal funds (balances held at Federal Reserve Banks) with each other overnight. When a depository institution has surplus balances in its reserve account, it lends to other banks in need of larger balances. In simpler terms, a bank with excess cash, which is often referred to as liquidity, will lend to another bank that needs to quickly raise liquidity. Source: Federal Reserve Bank of St. Louis.
The “core” PCE price index: Is defined as personal consumption expenditures (PCE) prices excluding food and energy prices. The core PCE price index measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices to reveal underlying inflation trends. Source: Bureau of Economic Analysis (BEA).

Sources: U.S. Bureau of Economic Analysis (BEA), Bureau of Labor Statistics (BLS), U.S. Department of Labor (DOL), Federal Reserve, Federal Reserve Economic Database (FRED), Federal Reserve Bank of Atlanta, U.S. Census Bureau, Department of Housing and Human Development (HUD), U.S. Department of Agriculture, U.S. Energy Information Administration (EIA), U..S Department of the Treasury, Office of the United States Trade Representative (USTR), U.S. Department of Commerce, data.gov, investor.gov, usa.gov, congress.gov, whitehouse.gov, U.S. Securities and Exchange Commission (SEC), Morningstar, The International Monetary Funds (IMF), The World Bank (WB), European Central bank (ECB), Bank of Japan (BOJ), European Parliament, Eurostats, Organization for Economic Co-operation and Development (OECD), National Bureau of Statistics of the People’s Republic of China, Organization of the Petroleum Exporting Countries (OPEC), World health organization (WHO).

Financial Markets – Recent Prices and Yields, and Weekly, Monthly, and YTD (Table): Bloomberg, Weekly Market Data is in USD and refers to the following indices: Macro & Market Indicators: Volatility (VIX); Oil (WTI); Dollar Index (DXA); Inflation (CPI YoY); Fixed Income: All U.S. Bonds (Bloomberg Aggregate Index); Investment Grade Corporates (Bloomberg US Corporate Index); US High Yield (Bloomberg High Yield Index), Treasuries (ICE BofA Treasury Indices); Equities: U.S. Industrials (Dow Jones Industrial Average); U.S. Large Caps (S&P 500); U.S Tech Equities (Nasdaq Composite); European (MSCI Euope), Asia Pacific (MSCI AP), and Latin America Equities (MSCI LA); Sectors (S&P 500 GICS Sectors) Source: Bloomberg. Fed Funds Rate probabilities, Source: CME FedWatch Tool.

Important Disclosures:

The views contained herein are not to be taken as advice or a recommendation to buy or sell any investment in any jurisdiction, nor is it a commitment from Amerant Investments, Inc. or any of its affiliates to participate in any of the transactions mentioned herein. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. It should be noted that investment involves risks, the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not reliable indicators of current and future results.

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Is Cash Really Worth It?