Cash Isn’t Trash Compared to Stocks and Bonds
The risks of a sharp selloff in both stocks and bonds is high at the same time, making cash an attractive haven
By Justin Lahart
Stock valuations are incredibly high, but the long-term Treasurys that investors typically use to safeguard their portfolios are shockingly expensive. Under these circumstances, the better hedge might be old-fashioned cash.
Almost any way you look at them, stocks seem quite expensive. The S&P 500 trades at about 22 times its expected earnings over the next year, its richest forward price/earnings ratio since the dot-com bubble. Against its inflation-adjusted earnings over the past decade—the valuation method popularized by economist Robert Shiller—it is similarly expensive. Other yardsticks, such as the overall value of U.S. stocks in comparison to gross domestic product, tell a similar story.
No valuation method is perfect of course, but when so many of them point in the same direction it is a reason for caution.
Indeed, about the only way to argue that stocks aren’t significantly overvalued is to compare them to long-term Treasurys.
The 10-year Treasury note yields just 0.72%, putting it near its lowest levels in history.
Against that, the low earnings yield on stocks (the inverse of the price/earnings yield, 4.5% on a forward basis) doesn’t seem so bad.
Whether stocks really are inexpensive in comparison with long-term Treasurys is an open question, especially because the low-inflation, low-growth environment that Treasury yields are predicated on calls into question the strength of future earnings growth.
One thing that seems clear, however, is that as an investment, Treasurys don’t have much room left for upside.
If worries about the economy became severe enough to send the 10-year’s yield down to zero, for example, its market value would rise by only about 7%.
In contrast, there could be plenty of downside. Consider a situation where next year a massive stimulus plan is enacted and a vaccine against the new coronavirus becomes widely available, the combination of which makes the economy really hum, while the Federal Reserve steadfastly keeps short-term rates near zero.
If that pushed the yield on the 10-year to 2.5%, the 10-year note would lose about 16% of its value.
Short-term Treasurys don’t carry anything like those downside risks, and their yields aren’t substantially lower than their long-term counterparts—the three-month bill’s is 0.1%.
A number of high-yield savings accounts have interest rates that approach or exceed the yield on the 10-year note.
When investors turn to cash, it is usually because market losses have made them deeply worried, leading them to miss out on gains made in the subsequent recovery.
But now, when both stocks and long-term Treasurys seem awfully expensive, a bit of cash might provide them with a margin of safety, and an easier night’s sleep to boot.
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