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Here’s something you don’t hear very often in the City of London: cash doesn’t get the attention it deserves as an asset class.
But SocGen’s strategist Dylan Grice wants to change that. He reckons there are times when it’s simply the best thing to own.
In a pithy little note published on Tuesday he explains why.
Cash has one important endowment which is too frequently unrecognized: a hidden optionality derived from its relative stability. In other words, the holder of cash has an effective option to purchase more volatile assets if and when they become cheap. Thus, a willingness to hold cash when there are no obvious alternatives is the simplest way to "?get long of the tails', and therefore the original "?long-vol' strategy.
Nevertheless, there is one tail risk you're still short of with cash: extreme inflation. Indeed, many clients today tell us the reason they don't feel comfortable owning cash is because they don't trust central banks to play fair with the value of cash. Regular readers will be aware that I fully share such concerns. But over time, nominal interest rates have generally tracked the rate of inflation, effectively compensating the holder of cash for any ongoing debasement. In the 1970s when inflation was double digit so were interest rates.
To illustrate the point, Grice produces the following chart:
The real total return to cash in the 1970s was actually on a par with bonds and equities, though on a risk adjusted basis cash was much better than either, because it was more stable. But note the value of that hidden optionality: only the holder of cash had the right to purchase other assets "“ equities or bonds "“ whenever their expected returns became attractive.
Fast forward 40 years and Grice reckons cash is now among the most attractive assets to hold, particularly for a US investor.
Consider the expected return of US stocks today. The S&P500 dividend yield is about 2%. Trend real dividend growth has been about 1% per year. So the expected income from owning the S&P500 here will be just over 2%. For expected capital gain, assume the cyclically adjusted PE ratio (CAPE) which is currently around 23x reverts to its mean multiple of 16x over the next ten years. That gives us a capital loss of just over 2% per year even after factoring in trend real EPS growth around 1.6%. My expected total real return on US equities is therefore around 0%. This is similar to the expected return of cash, only with much more risk (the front page chart plots that calculation over time and compares it to realised real returns).
Although adding a bit gold could juice up returns if the example of Turkey is anything to go by.
If we examine a more extreme inflation than that seen during the OECD in the 1970s "“ that of Turkey from the late 1970s to the late 1990s – we can see that the same blend (75% paper lira, 25% gold) delivered more purchasing power stability than the pure paper cash alternative, even during the extreme double and triple digit inflationary regimes seen in Turkey.
So maybe that's the best way to really bullet proof your portfolio, and what my friend, fund manager, Tony Deden calls the "?sacred savings' of your clients: a blend of cash, gold and a willingness to hold them until compelling value emerges elsewhere.
Hmm.
A fund manager sitting on cash until compelling value emerges? Now there’s an idea that could catch on.
Then again, perhaps not.
Related link: The global economy is critically ill – FT Alphaville
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