A long-term property bear told me this week that he was going to buy a flat. Why? He can’t bring himself to keep his money in cash when savings rates are 3%, inflation is 5% and income tax is 40%. But he can’t bring himself to buy much else either: most equities look overvalued; commodities could easily be on the edge of another cyclical peak; and there is only so much gold a man can hold. But his money “has to go somewhere”. And at least property offers some kind of yield.
I can see his points – holding cash in an era of negative real interest rates can feel painful. But what if it’s the least bad option? Dylan Grice of Société Générale points out that while it’s true cash “generally has a zero expected real return”, there is at least a “near-certainty around that expected return”. Mostly if you hold cash you know you won’t make money, but you won’t lose much either.
That’s not usually good enough. Most of the time, risk assets return more than 0%. So it makes sense to be biased towards equities, bonds, commodities, houses and wine instead of cash. But there are also occasions when risk assets are unlikely to return more than zero – times when the risk of losing money in non-cash assets is so high that it makes more sense to aim for a zero return than a real return. Now, says Grice, “might just be one of those times”.
Look at long-term valuations (such as the cyclically adjusted p/e) and you will find that the best return we can hope for from US equities over the next ten years is zero. That’s the same as the return on cash, “only with much more risk”. Other markets aren’t as expensive, but the point stands. Hold cash instead and barring hyperinflation you will get no return. But you will get stability at a low cost. You will also get a bonus – optionality: only “the holder of cash has an effective option to purchase more volatile assets if and when they become cheap”. That’s the thing that makes holding it (perhaps part in currencies and part in gold?) better than holding a flat that, while it might provide a yield, is also almost bound to provide you with a capital loss.
On a cheerier note, this week I interviewed Katherine Garrett-Cox. She’s had a bad press recently due to complaints from her activist investors and to the slightly mishandled buy-back scheme they have apparently forced her into. Alliance’s performance has also, by her own admission, been “less than sparkling”. However, change is afoot. Garrett-Cox has started to take a firm line with her detractors; she is addressing the performance problem; and Alliance still offers what she thinks her thousands of small investors want – a diversified global portfolio and a rising dividend. If that is what you want too (ie, you don’t entirely agree with Dylan), it’s worth looking at.