Broker Check

In these times of market ebullience, what is the point of holding bonds and cash?

| February 01, 2018
Share |

“And it never failed that during the dry years the people forgot about the rich years, and during the wet years they lost all memory of the dry years. It was always that way.” -John Steinbeck, East of Eden

Globally synchronized expansion has given us an astoundingly consistent bullish run in the markets.

The Fear of Missing Out (FOMO) factor is not limited to today’s rampant social media consumption.

“It feels stupid to own cash in this kind of environment," Hedge Fund Titan, Ray Dalio said in a Bloomberg News interview in Davos last week.[1]

Larry Fink, CEO of BlackRock, the world’s biggest asset manager, echoed the bullish sentiment a couple days later in a Davos interview as he played up the huge pool of cash investors have sidelined throughout the world. He said that 45% of disposable income in China is held in cash and 72% of all French savings is held in a bank account. Mr. Fink shudders to think of the massive growth potential investors around the world are missing as the stock market wings ever higher.[2]

So, the barons of Wall Street are ushering investors to jump in to stocks. This marks a pronounced change in sentiment since the passage of the tax bill in late December.

The measured and cautionary voices speaking of stocks as broadly overvalued have only recently been drowned out by widespread market exuberance.

Why the dramatic turn?

The U.S. economy has been growing at an average pace of 2.2% over the past five years and over the last two decades as well.[3] Many economists have suggested we prepare ourselves for a “new normal” in U.S. economic times, meaning a prolonged period of sluggish growth.

Proponents of the benefits of tax reform remain focused on achieving a 3% GDP rate of growth in the coming years. If we successfully hit the 3% target and even bounce around in the 3% range, as Larry Fink suggests is possible, markets are poised to edge even higher.

In these times of market ebullience, what is the point of holding bonds and cash?

Let’s be real, there is no such thing as a perfect investment – one that always goes up.

Even optimists must admit that political disruption, a spike in inflation, or a tightening monetary policy would disrupt a Goldilocks scenario of strong market growth. These are apparent risks that give good reason to diversify beyond stocks.

Bonds tend not to have as high of an up-side as stocks do so growth-oriented investors may question their appropriateness during a bull market. Although investing in bonds bears its own unique risks, they can provide long-term appreciation.[4]

  • The main reason to invest in bonds, generally, is to have a smoother ride.[5]
  • Holding cash gives you the freedom and power to buy.

Using bonds and stocks together in a balanced portfolio has performed even better than a pure stock portfolio since the year 2000.[6] The occasionally big dips in stock prices take time to recover from so the steady returns of bonds cushion the blow and keep your portfolio moving upward more consistently. Having cash on hand when market cycles change allows you to obtain the lowest price when others are desperate to sell.  

I’ll have what she’s having.

Our natural tendency is to flock to high-performing investments and avoid those that are under-performing. This results in stock bubbles. People want to get in on the good stuff, whether that is Bitcoin in 2018, tech stocks in 1999 or the first recorded speculative bubble in tulips in the early 1620’s.

Fear of missing out on the latest and greatest market run can over-ride our memories of the past. Maintaining a balanced perspective on markets and a balanced portfolio go hand-in-hand.

As the Wall Street titans beckon – “Jump in, the water’s fine!”, don’t forget the lessons you’ve learned in the past and remember, balance is everything.[7] 

*The opinions and forecasts expressed in this piece are those of the author and may not actually come to pass.  This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan.  Past performance does not guarantee future results.

All material contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Past results are no guarantee of future results and no representation is made that a client will or is likely to achieve results that are similar to those shown. Please refer to disclosure document for additional information and risks.

//

*cartoon by Richard Cline

[1]https://www.cnbc.com/2018/01/23/ray-dalio-says-market-surge-may-be-ahead-if-youre-holding-cash-youre-going-to-feel-pretty-stupid.html

[2]https://www.bloomberg.com/news/articles/2018-01-25/blackrock-s-fink-joins-dalio-in-warning-against-sitting-in-cash

[3]https://www.thebalance.com/us-gdp-by-year-3305543 

[4] In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk, liquidity risk, call risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible. 

[5] Investing in bonds does not protect from volatility or investment loss and diversification does not assure a profit or protect against loss.

[6]https://www.wsj.com/articles/it-has-been-a-near-perfect-investing-environment-but-it-may-end-soon-1516642590

[7] Diversification and/or asset allocation does not necessarily protect an investor from losses in a down market.

 

Share |