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‘Cash Very Rarely Outperforms’: Why Wall Street is Rethinking its Love of Cash

By Vildana Hajric and Peyton Forte

Wall Street investors sitting on a pile of cash could start considering other opportunities, with the Federal Reserve possibly heading for a pause in interest-rate hikes, according to Tom Kennedy, chief investment strategist for global wealth management at J.P. Morgan. 

Photo by Tima Miroshnichenko:

“Cash very rarely outperforms, and it takes a long time for rates to go up, but they can come down really fast,” Kennedy said on the What Goes Up Podcast. He also estimated that his company’s clients are the most overweight cash now than they’ve been in a decade.

Here are some highlights of the conversation, which have been condensed and edited for clarity. Click here to listen to the full podcast or subscribe below on Apple Podcasts, Spotify or wherever you listen.

Q: What do you expect from the Fed going forward?

A: The Fed has been on a five-step journey to bring inflation down toward trend. The first step is to tighten financial conditions. The primary tool to do that is to hike rates. And for all of us regular people, that should change your decision. Step two is those rate hikes impact the most interest-rate-sensitive sectors of the world. When interest rates go up, housing is the part of the economy that tends to respond first. Home-sale prices in America are going down sequentially — not a lot. Home prices went up a lot, they’re coming down a little bit. But it’s evidence now that rates are high enough and people need to change their decisions.

It’s a very short cycle and we have seen the impact there. So step one is raise rates. The Fed did that — 500 basis points. Step two is the most interest-rate-sensitive sectors respond — we’re there. Step three is now those high rates have to impact corporations. How do rates do that? Higher rates actually limit the ability to borrow money and do capital investment. J.P. Morgan does billions of dollars of capital investment every year. If rates are too high, we can’t borrow and can’t do the capital investment. If that’s true, we’re taking money or revenue from another business and so on. We’re in that phase. And when revenues in the system start to slow, as we’ve seen in in the S&P 500 as an example — in Q1 revenues relative to year ago are down 4%, give or take. What do businesses do? They tend to defend their earnings and they can either cut capex more or more likely end up having to do some sort of layoffs — and then finally inflation comes down. So a five step process, I think we’re about halfway there. We should expect to see some level of layoffs in the back half of this year.

Q: You say that your clients are the most overweight cash they’ve been in the last 10 years. I’m wondering — for somebody who is in cash right now, what are you recommending that they actually be doing? 

A: The first is to acknowledge why they have such overweights to cash. For the first time since 2006, you can get 5% yields risk-free. A really important anchor point is to say, well, for the last 10 years I’ve been really investing in equities. Great — they’ve done very well for you. Over a long horizon, say since the year 2000, the S&P 500 has annualized you 7%, give or take. Wow, man, that felt great. Well, now you can take almost no risk or near-zero risk and get 5%. So the raising of cash makes sense to me. But is it possible that a 5% rate, which is only an overnight rate, can change and change very quickly? Think yes. 

More likely than not, I think the Fed is done with the hiking cycle. Rates are restrictive enough, the employment picture’s still strong, things are softening. But you’re also getting an inflation stabilization, which means that they may not need to chase it. So I really challenge clients: I know you love 5% overnight. If you love it overnight, why don’t you lock in that yield for three, four, five years? 

Cash very rarely outperforms, and it takes a long time for rates to go up, but they can come down really fast. The last seven business cycles, when you have the last rate hike from the Fed, in the two years after that, cash tends to underperform duration assets by 14%. 

Q: Where do you think investors can put money to work right now?

A: Year to date, the S&P 500 has performed well. The top mega-cap names — let’s not even call them tech names — have pulled the index higher. Over a longer horizon, let’s say the last year, the last 15 months, the S&P 500 been trading in a very tight range. The same can be said about bonds. So in a late-cycle environment, you have to be active, you have to be using statistical valuation tools to try to navigate this process. First question is what’s inexpensive? If we’re worried about a recession, what’s pricing in that risk already? Mid-cap stocks in America, European stocks. What’s really interesting about those two things is our clients in the J.P. Morgan community globally are underweight both.

This is something to talk about. We can diversify late cycle and these things are giving me a little bit more cushion, should we hit the unfortunate recession. In America, same process, where can I find defensives, things like health care and even some reasonably priced tech names. Where is there valuation support? That’s more or less critical for our investment committee.

–With assistance from Stacey Wong.

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