2021 is off to an inauspicious beginning. Through 10 days, COVID infections in the U.S. have hit record daily numbers, U.S. COVID deaths have topped 373,000, the Capital Building was overrun by a group of misguided individuals seeking to take back the country, Congress intends to impeach the President (again) and the DOW, S&P 500 and the NASDAQ are all bumping against record levels. With an abundance of negative forces in place, why has the market proven to be unstoppable and resilient?
A Mountain of Cash
The Federal Reserve has committed to keeping interest rates at or near zero at least until 2023. That decision impacts the economy in ways that few fully understand. For purposes of this essay, our goal is having readers connect the dots between ultra-low rates and stock prices.
Today individuals and corporations are holding the largest cash reserves ever recorded. These massive reserves ultimately meet different needs based on the goals of the holder. Consider these alternatives:
- The fearful individual holds excess cash to meet spending needs over the next several years and is comforted by the larger reserves;
- A wealthy investor holds excess cash because she believes stocks are overvalued and a better entry point awaits;
- A profitable corporation holds excess cash because its leadership believes that the cash can be used:
- To weather a pending economic downturn;
- To infuse expansion capital into the business;
- To buyback the company’s stock;
- To acquire another company; or,
- For one of many other possibilities.
This incomplete list of alternatives is offered for the sole purpose of establishing the base case that significant cash reserves are held for a purpose, and ultimately that purpose is either achieved – which means the cash is used, or not. If not, the cash continues to be retained until the objective is met. Said another way, sooner or later, the cash is either spent and therefore finds its way into the economy or used for further investment. In conclusion, the cash provides a safety net for the holders and for the economy – a welcome combination.
Despite the arrival of vaccines, millions continue to fear contracting the virus and behave accordingly. Governments throughout the world have been forced to reimpose lockdowns to slow the virus. Travel and hospitality continue to be negatively affected. Analysts now predict the industry will return to normal in 2024. For the sake of all those employed by hotels, restaurants, theme parks, airlines, theatres… we pray the analyst are wrong.
Drs. Goetlieb and Fauci agree that the herd immunity in the U.S. is unlikely to occur in 2021 as the vaccination rate remains slow and the virus variants emerge. As such, one should not be surprised that fear of infection remains high. Ongoing fear results in continuing behavioral change. One glaring change — the hoarding of cash.
Connect the Dots
With the exception of individuals comforted by a six-or-seven-digit cash reserve earning pennies, most ultimately choose to have the cash working. Be it corporate CFO’s or individuals caring for their nest eggs, the goal is to balance risk of loss with potential reward.
When the Federal Reserve keeps treasury rates near zero, the safest alternatives typically reflect the same near-zero outcome. Bank deposits, CD’s, and money markets mirror the near zero outcomes. As a result, money begins to move across the risk curve. Investment grade corporate bonds, high-yield corporate bonds, dividend paying stocks, and REITs become alternatives for those in search of yield. As the DOW and S&P move higher, investor fear-of-missing-out begins to impact and replace well-conceived investment plans. Ultimately, investor asset allocations become overexposed to equities at precisely the wrong time…and the “greater fool” theory is fulfilled.
Institutional Investors understand that adherence to a well-conceived Investment Policy Statement (IPS) results in a portfolio where risk is managed and returns are achieved over time. Savvy individual investors do the same. Having a plan with defined risk parameters results in an asset allocation designed specifically to meet the stated goals of the investor. Following the plan – allowing neither fear nor greed to alter the path — allows investors to reach their destination.
At PWA, our goal is to help clients achieve their goals. With market valuations relatively high, we choose to manage risk through asset allocation and security selection. Ultimately, our efforts are aligned with our client’s goals, timelines, and risk appetite, as reflected in a Goal Policy Statement (GPS).
On behalf of my PWA colleagues, we thank you for continued trust and confidence.
Joseph A. Scarpo
Founder & CEO