MONDAY, MAY 28, 2012
Investors--professional
and individual alike--need a safe place for at least a portion of their assets.
Cash or money-market funds historically served this purpose.
The most esteemed professional
investors, who effectively have carte blanche when managing client assets,
can set aside large portions of clients' assets when the investment
outlook is cloudy or exceptionally risky. Unfortunately most managers
aren't permitted the latitude to do so and must remain close to 100% invested,
regardless of the overall investment outlook.
The expression "put
money to work" is one of the most hackneyed in the professional investment
business. Watch CNBC for only a short time, and you are likely to hear it
as a defense of putting cash reserves in the stock market. A variation
is, "Clients don't pay us a management fee to sit on cash." The
simple point is that there is considerable pressure on most professional
investors to look like they are earning their fees by being active, regardless
of whether valuations are sufficiently attractive to provide a favorable
return/risk tradeoff.
This is especially true
currently, as cash yields almost nothing. It is even more difficult to be
patient in waiting for better investment opportunities under this condition.
Similarly for individual
investors, savings and money market account yields of nearly zero percent exert
pressure to earn potentially higher returns from bonds that expose the investor
to the possibility of large swings in portfolio values from either bonds or
stocks. The notion of "saving for a rainy day" seems quaint
these days, as "cash is trash" more aptly describes today's mindset.
There has been an
effective alternative to cash since 2000. Gold not only provided a superb
alternative store of value by exceeding the rate of inflation. It was a
superior investment as well, with an annualized return of approximately 17%
since 2000 (versus low to mid single-digit returns for stocks and bonds).
Lately, however, the price
of gold has fallen 18% since its peak last autumn.
Short-term supply/demand problems from India and Europe are probably
factors for the decline. Yet, the underlying global monetary policy
environment is supportive of gold prices. Short-term interest rates are
still negative after subtracting the rate of inflation, and gold prices have
tended to rise historically under this condition. What is an investor to
do?
Some of the largest
investors who can't or won't hold cash or gold have used U.S. Treasury Notes as
a safe place to park funds. U.S. Treasuries are easy to buy and sell, and
when anxiety forces selloffs in stock markets, Treasuries have risen in price.
But U.S. Treasuries are not risk-free. With the U.S. Federal
Reserve aggressively intervening to support markets and economic activity to an
unprecedented extent, it seems only a matter of time before inflation rises or
investors lose confidence in holding U.S. Government securities in anticipation
of higher interest rates (and consequent capital losses on Treasury
securities).
Another potential problem
for U.S. Treasuries could be unexpectedly positive developments in Europe.
If the European financial crisis impels the Euro nations to agree to
issue bonds for the entire Euro nations--including those financially strong and
those financially weak--that could produce a flow of investment funds away from
U.S. Treasuries and toward Euro bonds. Price of U.S. Treasury securities
would fall and those of Europe would rise.
Since the 2008 financial
crisis, there seems to have been an inexorable decline in yields on U.S.
Treasury notes and bonds. But this actually has gone on for much longer
than that, as long-term U.S. Government bond yields have been declining since the
peak in 1982.
This 30-year period of
declining interest rates (and rising bond prices) must be coming to a close.
While the yield on the 10-year U.S. Treasury Note could fall further from
the current 1.75% level, particularly if Europe has further setbacks, I would
look to exit U.S. Treasury holdings.
So is there a reliable
store of value for the short to intermediate term? I think there are
three: cash, gold, and short- to intermediate-term investment-grade
corporate bonds.
Steve Lehman
LehmanInvestblogspot.com/
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