The September and October market volatility after seven months of gains inevitably led some investors to wonder if it was time to “go to cash” before the big correction. The S&P 500 suffered its first 5% decline in over a year and volatility is not expected to subside as earnings season begins and companies face earnings growth and margin pressure, with labor and input prices rising and the global supply chain still chaotic. Investors are likely to have a quick trigger finger with any disappointments in guidance.
“The froth has continued, and the question is only time will tell how long that will go,” said J.P. Morgan Asset & Wealth Management chief executive officer Mary Erdoes, speaking at the recent CNBC Delivering Alpha conference. “It’s just really a question of how patient investors are and with the time value of money being nearly zero, people should be quite patient with what they’re investing in.”
History says investors struggle to be patient, and market jitters inevitably result in some investors making the decision to sell stocks. For some, reducing exposure to equities may be a prudent one — if an individual is near or in the retirement phase of their investing life where income takes on greater significance than absolute equities’ appreciation they may be overweight the U.S. market today.
But for most investors with a longer time horizon — and even for retirement-age investors — the decision to go to cash should not be a binary one between either being in the stock market or out. All the research says that tends to be a bad decision. Going to cash requires being right twice — when you get out, and when you decide to get back in. And it’s the latter that often has major consequences for investors. Far too many people become tentative about getting back in and miss long periods of gains.
The history of market corrections, bear markets, and rebounds, shows that a do-nothing approach tends to benefit investors with time more than a go-to-cash approach, but according to top institutional investors, neither is the best way to act. Research has consistently shown that time in the market is more important than perfect timing, but that does not mean money should not move from one part of the market to another on a relative valuation basis. Investors should always be ready to go to cash so they can seize opportunities in the market rather than cutting and running from it. There should always be a portion of a portfolio in holdings that can be turned into cash to take advantage of market downturns and pour more money into depressed securities.
Don’t be a forced seller. Be ‘super cash efficient.’
“You never want to be a forced seller of risk assets at reduced prices because of market turmoil that locks in permanent capital impairment,” said Ashbel Williams at Delivering Alpha. Williams, who recently retired as executive director and chief investment officer for the roughly $200 billion portfolio at the Florida State Board of Administration, explained that the decision to go to cash is really a decision to rebalance into equities while they are down.
“There always has to be liquidity when equity markets go down,” Williams said. “The No. 1 way to protect capital is to follow investment policy and rebalance back into equities while at depressed prices.”
That message was reiterated by several top money managers at Delivering Alpha.
“We are super cash efficient and rebalance quite a bit,” said Elizabeth Burton, chief investment officer for the Employees’ Retirement System of the State of Hawaii. She described being “super cash efficient” as the most important strategy for the state portfolio’s bottom line and said there is never a period of time when as an investor she can afford to not be in equities.
Thinking about cash in the right way takes on greater significance during periods of time when investor tolerance for risk and patience is being tested by market volatility, and the U.S. stock market in particular has posted what investors see as “atypical” returns. Many of the top investors who spoke at Delivering Alpha expect lower returns from U.S. stocks in the future and are already hunting for depressed opportunities in equities around the globe, including in Europe and China.
“This is not a normal time period,” Erdoes said.
Investors are taking various approaches to a near- to mid-term equities outlook which gives them pause. Hedging inflation risk with real assets including real estate, alternative assets including cryptocurrency, and a focus on hyper-growth companies rather than broader market gains, are among the ways that investors are making allocations amid what they view as a U.S. stock market running a little hot.
“The easy gains off the Covid bottom have certainly been made,” said Brad Gerstner, chairman and CEO of Altimeter Capital at Delivering Alpha. He sold some travel stocks and has taken down his net long exposure to 50%, but he has been buying some growth names that were beaten down after a Covid surge, such as Zoom Video and Peloton.
Negative rates and portfolio liquidity
Within a traditional stock and bond portfolio, where to keep assets in a more liquid bucket so they can be liquidated when an opportunity to rebalance presents itself is a greater challenge in a world of negative real rates making bonds unattractive.
“Negative real rates are here to stay, 74% of the global AG has negative real rates, every single U.S. treasury maturity has a negative real rate and the time value of money is really nothing,” Erdoes said.
Liquid assets like treasuries, which investors can buy and sell quickly and usually appreciate in value in times of turmoil, have historically been a good method of generating proceeds to rebalance into equities and participate in a rebound.
“That’s exactly what we did in March 2020, selling treasuries … and did it in 2009,” Williams said. “You always need to have something you can go to cash with to rebalance.”
Williams said his state investment asset allocation policy historically had a treasuries bucket as high as the mid-20s on a percentage basis and that is now down to just under-20%, which is still enough to meet rebalancing needs. But the state board also is using substitutes for bonds in a negative real rate world.
“That often means owning things … planes, trains, timber, rights to music and TV shows, theaters, all things that can create cash flows, not market correlated,” Williams said.
“Collectibles, if you have an edge there, like a family office, those might be a good place to sit for a while,” Burton said.
But for most investors, if they do not have the edge of a multi-billion institutional investor with access to both private and alternative asset classes, the best thing they can do when markets are volatile: use cash to rebalance rather than sit in cash for too long.
