Suddenly, cash has rarity value

Roger Montgomery

When should you hold more cash? The simple answer is: when fewer people are holding it. Because that’s when it’s most valuable. And, right now, after the stampede to other asset classes, cash is more valuable than it has been for some time.

When central banks around the world acted collectively to drive short term interest rates to zero and then to flatten the yield curve by also buying global long term bonds, they triggered a mass migration of investors out of cash and into every other asset class.

As US 10 year bonds fell from nearly 16% in 1980 to 1.36% last year, yields on all assets fell amid a migratory buying frenzy that ignored quality and longer-term growth prospects. The yield on the S&P500 has declined from above 6% in 1981 to just over 2% today. In 1992 Australian industrial property offered a yield of 12%, today it offers about 6.5%. Retail property offered 9% in 1992 and today it is 5.75%. A year ago, triple-C rated bonds (Junk Bonds issued by the highest risk companies) yielded 9% more than bonds issued by the US Treasury. Today that difference is just 4%. Hong Kong residential property yields have declined from over 11% in 1982 to less than 3% today, and in Australia residential yields of over 9% in 1987 have fallen to less than 3%. Bond proxy infrastructure stocks Transurban and Sydney Airport have seen their dividend yield fall from more than 12% in 2008/09 to less than 6% today.

If you aren’t selling the above assets at today’s prices you are effectively buying and what you are buying is a long duration asset with an inadequate income. The classic response of course is that while the income is poor investors will do well from capital gains. This misses the point that in order to make a capital gain the next buyer one sells to has to accept an even lower yield. Capital gains don’t occur in a vacuum. In order to sell there must be a buyer, and that buyer must be an even greater fool to accept an even lower yield.

Of course, there is nothing to worry about right now – everything appears rosy and asset prices aren’t falling. Why be concerned? Quite simply, as bond rates continue rising from their recent lows, the fixed incomes of many assets will be less valuable. Investors will start reappraising their investment strategies and they will question the sense of locking in such low returns for multi-decade periods on multi-decade assets.

And that’s where liquidity becomes important. I completely understand the logic of not holding cash in a low interest rate environment. Cash only yields 2.5%. But now many less liquid assets yield the same amount but with much higher capital risks and far less liquidity. I challenge 20,000 readers to try and sell their leveraged apartment at a 10% profit today. I’d be surprised if in aggregate that is possible. I challenge 100,000 readers to sell their recently purchased leveraged apartment at break even! As billionaire Sam Zell once observed, liquidity is value. Only when you can actually sell is the value you have put on your asset correct. In a market full of investors trying to exit, market values will change suddenly.

So ask yourself: if I need to get out in a hurry, will I be able? If you aren’t leveraged and you don’t mind riding a cycle or two, you have little to worry about. And if you have another income stream that allows you to add to your portfolio at lower prices, again you have little to worry about. But cash is most valuable when nobody has any. And given the migration that drove asset prices higher, few have any. If there’s a migration back to cash, illiquidity could trigger a significant fall in asset prices.


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