With central banks keeping rates “higher for longer”, cash may look competitive right now. But cash comes at a cost, and other assets could offer investors even better opportunities.
Our Top Market Takeaways for September 25, 2023.
Market update
Higher for longer
Stocks were down as bond yields surged last week. Both 2-year and 10-year Treasury yields are hovering around their highest levels since 2007, as central banks—from the Federal Reserve to the European Central Bank and Bank of England—have all signaled they plan to hold rates at high levels for some time.
Digging in, the Fed hit “pause” after 525 basis points worth of rate hikes over the last year-and-a-half. As policymakers refreshed their projections for the years ahead, they signaled one more hike could be on the cards this year, and that there could be fewer cuts in 2024 and 2025 than they initially expected. While growth has held up well, and that’s a good thing, it has also meant that inflation has lingered.
This chart shows the Fed funds rate with the FOMC median dot plot projections for June and September. The Fed funds chart starts at 0.125% and stays there until March 2022. From there, it increases rapidly. The rate jumps to 0.375%, followed by 0.875% in June 2022, 1.625% in July 2022, 2.375% in September 2022, 3.125% in October 2022, and 3.875% in December 2022. The pace of rate hikes then slows in 2023, rising to 4.375% in January and then slowly rising in 0.25% increments to the current level at 5.375%. The median dot plot for the September and June FOMC projections shows the following rates for the end of each year: 2023: September – 5.625%, June – 5.625% 2024: September – 5.125%, June – 4.64% 2025: September – 3.875%, June – 3.375% 2026: September – 2.875% Longer-run: September – 2.5%, June – 2.5%
The Bank of England surprised with its own pause on Thursday, but even as it signalled more tightening may be needed to get inflation back in check, the decision to “hold” (along with rhetoric from a host of other central banks in Europe) signalled that a “higher for longer” mindset is unfolding on this side of the pond, too.
In all, we think the data still points to more reasons to be optimistic than not, particularly in the U.S. Policymakers have made a lot of progress in quelling price pressures with minimal economic pain. But we do acknowledge that the list of risks to the outlook is long (from oil prices to strikes, to student loan payments, to a potential government shutdown, to a policy mistake of overtightening). This uncertainty has prompted many to sit in the safety of cash—especially when it sports a yield of over 5%. But is that really your best bet?
Spotlight
Should you stay stashed in cash?
As cash has grown more alluring, it’s looked all the more difficult for other assets to beat it.
Yet despite all the uncertainty—around banks, policy, growth, inflation, government debt and more—many other areas of the market have outperformed cash this year.
If you bought T-bills at the start of 2023, your return so far would be around +3.6%. That might not feel too bad for the safety cash has offered. But by comparison, global stocks have returned +13%, and 25 out of 48 country stock markets we track have also beaten cash. Even after the recent selloff, the S&P 500 is up +14%, and despite all the focus on mega-cap tech (the Magnificent 7 are up an eyepopping +83%), about half the companies in the index have also outshined cash’s return. U.S. high yield bonds are likewise up a more meaningful +6%.
This chart shows the percentage total returns in USD of various categories. For U.S., the total return in 2023 is 13.9%. For World, the total return in 2023 is 12.5%. For Europe, the total return in 2023 is 10.0%. For a 60/40 portfolio, the total return in 2023 is 6.8%. For U.S. Corporate HY, the total return in 2023 is 6.3%. For Gold, the total return in 2023 is 5.8%. For USD Cash, the total return in 2023 is 3.6%. For EM Equity, the total return in 2023 is 3.3%. For Asia ex-Japan, the total return in 2023 is 1.0%. For U.S. Agg. Bonds, the total return in 2023 is -0.2%. For U.S. Treasury, the total return in 2023 is -0.9%. For Global Agg. Bonds, the total return in 2023 is -1.3%. For Commodities, the total return in 2023 is -2.3%.
But have you missed it? With “higher for longer” rates now dialling up the pressure on both stocks and bonds, earning more than 5% to lend money to the U.S. government (and around 4% in Europe) might feel even tougher to beat.
Cash has a purpose, and it can be a critical part of any investor’s plan. But looking forward, we are reminded it comes with a cost. Multi-asset portfolios are designed to navigate across a range of different scenarios.
Let’s say that we avoid a recession and achieve a “soft landing”.
In that scenario, riskier assets such as stocks have potential to outperform. Almost all of the swings in markets this year have been at the behest of valuations, with sentiment oscillating around the headlines. But earnings growth is just getting started. The Q2 season was better than anticipated, and also seems to have marked the worst of it. Looking forward, S&P 500 earnings expectations are rising, not falling.
In the long term, this matters a lot: over the last three decades, the S&P 500 has cumulatively returned over 1,700%; 99% of that return is due to earnings and dividends, and only 1% from changes in valuations.
For December 1993, the dividend contribution was 2.9%, the earnings contribution was -4.9%, and the valuation contribution was 5.66%. For December 1992, the dividend contribution was 7.9%, the earnings contribution was -41.5%, and the valuation contribution was 112.4%. For December 1993, the dividend contribution was 12.5%, the earnings contribution was -14.8%, and the valuation contribution was 74.3%. For December 1994, the dividend contribution was 16.5%, the earnings contribution was -2.1%, and the valuation contribution was 51.6%. For December 1995, the dividend contribution was 27.4%, the earnings contribution was 33.1%, and the valuation contribution was 66.8%. For December 1996, the dividend contribution was 38.5%, the earnings contribution was 91.3%, and the valuation contribution was 47.1%. For December 1997, the dividend contribution was 56.4%, the earnings contribution was 116.6%, and the valuation contribution was 82.4%. For December 1998, the dividend contribution was 77.9%, the earnings contribution was 120.1%, and the valuation contribution was 139.4%. For December 1999, the dividend contribution was 99.7%, the earnings contribution was 157.0%, and the valuation contribution was 153.5%. For December 2000, the dividend contribution was 95.1%, the earnings contribution was 188.5%, and the valuation contribution was 97.9%. For December 2001, the dividend contribution was 88.2%, the earnings contribution was 141.7%, and the valuation contribution was 100.6%. For December 2002, the dividend contribution was 72.9%, the earnings contribution was 154.3%, and the valuation contribution was 35.2%. For December 2003, the dividend contribution was 99.7%, the earnings contribution was 197.0%, and the valuation contribution was 54.4%. For December 2004, the dividend contribution was 116.7%, the earnings contribution was 264.1%, and the valuation contribution was 36.7%. For December 2005, the dividend contribution was 129.2%, the earnings contribution was 333.5%, and the valuation contribution was 15.0%. For December 2006, the dividend contribution was 157.5%, the earnings contribution was 383.4%, and the valuation contribution was 19.6%. For December 2007, the dividend contribution was 174.2%, the earnings contribution was 399.1%, and the valuation contribution was 20.5%. For December 2008, the dividend contribution was 116.1%, the earnings contribution was 301.5%, and the valuation contribution was -21.1%. For December 2009, the dividend contribution was 154.7%, the earnings contribution was 230.5%, and the valuation contribution was 37.1%. For December 2010, the dividend contribution was 185.4%, the earnings contribution was 368.6%, and the valuation contribution was 5.1%. For December 2011, the dividend contribution was 197.1%, the earnings contribution was 454.0%, and the valuation contribution was -16.3%. For December 2012, the dividend contribution was 238.1%, the earnings contribution was 477.4%, and the valuation contribution was -4.5%. For December 2013, the dividend contribution was 326.8%, the earnings contribution was 523.9%, and the valuation contribution was 24.5%. For December 2014, the dividend contribution was 383.9%, the earnings contribution was 574.2%, and the valuation contribution was 30.6%. For December 2015, the dividend contribution was 401.9%, the earnings contribution was 567.8%, and the valuation contribution was 30.9%. For December 2016, the dividend contribution was 464.3%, the earnings contribution was 556.9%, and the valuation contribution was 50.8%. For December 2017, the dividend contribution was 581.4%, the earnings contribution was 651.1%, and the valuation contribution was 61.2%. For December 2018, the dividend contribution was 570.3%, the earnings contribution was 826.5%, and the valuation contribution was 13.3%. For December 2019, the dividend contribution was 768.9%, the earnings contribution was 826.9%, and the valuation contribution was 59.1%. For December 2020, the dividend contribution was 930.5%, the earnings contribution was 657.2%, and the valuation contribution was 142.6%. For December 2021, the dividend contribution was 1217.3%, the earnings contribution was 1098.1%, and the valuation contribution was 90.5%. For December 2022, the dividend contribution was 1015.3%, the earnings contribution was 1177.0%, and the valuation contribution was 33.3%. For August 2023, the dividend contribution was 1220.0%, the earnings contribution was 1181.05%, and the valuation contribution was 63.74%.
And when it comes to beating cash, let’s say it keeps its juicy 5% yield over the long term (already a lofty assumption, given, at some point, central banks will start cutting rates). Let’s also assume global stocks earn 8.5% per year, in line with J.P. Morgan Asset Management’s Long-Term Capital Market Assumptions. The difference may feel small today, given cash comes with a lot more certainty, but after five years, hiding out in cash would trail your equity return by more than 20%. After 10 years, it grows to an eyepopping ~60%. The power of compounding leads to big differences over time.
This chart shows the compounded returns of Cash and All-Country World Equities over the course of the next 10 years, assuming a 4.4% rate on Cash and 8.5% on the MSCI ACWI. In year 1, the compound return for cash is 4.4% and the compound return for the MSCI ACWI is 8.5%. In year 2, the compound return for cash is 9.0% and the compound return for the MSCI ACWI is 17.7%. In year 3, the compound return for cash is 13.8% and the compound return for the MSCI ACWI is 27.7%. In year 4, the compound return for cash is 18.8% and the compound return for the MSCI ACWI is 38.6%. In year 5, the compound return for cash is 24.0% and the compound return for the MSCI ACWI is 50.4%. A marker emphasizes the ~25% difference after 5 years. In year 6, the compound return for cash is 29.5% and the compound return for the MSCI ACWI is 63.1%. In year 7, the compound return for cash is 35.2% and the compound return for the MSCI ACWI is 77.0%. In year 8, the compound return for cash is 41.1% and the compound return for the MSCI ACWI is 92.1%. In year 9, the compound return for cash is 47.3% and the compound return for the MSCI ACWI is 108.4%. In year 10, the compound return for cash is 53.8% and the compound return for the MSCI ACWI is 126.1%. A market emphasizes the ~70% difference after 10 years.
Or maybe we do get that recession.
Different pockets of fixed income can help achieve different goals. Cash and money market funds may offer a yield boost for your day-to-day liquidity needs, but if your goal is income, taking a little bit more credit and duration risk with short-duration corporate bonds can offer an even more meaningful pickup in yield—and still help you to lock in elevated rates for longer.
And if we do face a meaningful or protracted growth slowdown, bonds offer stability and protection. Bonds tend to do well when equities don’t, and during the peak-to-trough of the Global Financial Crisis, U.S. core fixed income returned 7%, while T-bills only returned 2%. Timing the right entry point is hard, but it’s worth noting how much pain is already reflected in bond prices: Bloomberg’s Global Aggregate Bond Index closed at its lowest level of 2023 on Thursday.
Or let’s say inflation reaccelerates.
In a world where inflation hangs around even longer than already expected, or at worst reaccelerates and prompts another wave of central bank rate hikes, alternatives such as real assets can offer more protection—as well as access to long-term trends such as industrial policy and the energy transition.
Case in point: In 2022, while public markets sank, assets such as infrastructure offered ample protection. Moreover, with rates higher and lending standards getting tighter, direct lenders have been stepping in as banks have been more reticent to take on new loans. This has created a compelling environment for private credit.
This chart shows the 2022 returns in percentage terms of alternative assets as of December 31st, 2022. In 2022 the return for timber was 12.9%. In 2022 the return for infrastructure was 9.7%. In 2022 the return for US core real estate was 7.5%. In 2022 the return for direct lending was 6.3%. In 2022 the return for Europe core real estate was 4.6%. In 2022 the return for private equity was -2.7%. In 2022 the return for hedge funds was -2.8%. In 2022 the return for global high yield was -11.845%. In 2022 the return for the MSCI Europe was -14.525%. In 2022 the return for the TOPIX was -14.87%. In 2022 the return for global investment grade was -16.72%. In 2022 the return for global government bonds was -16.78%. In 2022 the return for the S&P 500 was -18.11%. In 2022 the return for venture capital was -18.4%. In 2022 the return for MSCI China was -21.798%. In 2022 the return for global inflation linked was -22.95%.
So this is all to say a 60/40 portfolio of stocks and bonds remains one of the best starting points in our view, offering investors the potential for growth and income. But alternatives can add an additional element of diversification and help position for a world in transition.
Investment considerations
Cash doesn’t rally
Cash comes with an opportunity cost—by sitting in cash, investors may miss out on the potential upside stocks could see in a soft landing, lack the protection that bonds can offer if a recession does happen, and lose out on the inflation protection that real assets have.
We’ll echo what we said on this topic earlier this year: take an opportunity to step back. Think again about how much liquidity you really need. If you have excess capital in cash and cash equivalents, we see a range of options across the risk spectrum that could potentially give you higher returns over the long run.
Your J.P. Morgan team can help you reassess how much cash you need and where excess capital might be deployed to reach your family’s goals.
All market and economic data as of September 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
RISK CONSIDERATIONS
- Past performance is not indicative of future results. You may not invest directly in an index.
- The prices and rates of return are indicative, as they may vary over time based on market conditions.
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- Opinions expressed herein may differ from the opinions expressed by other areas of J.P. Morgan. This material should not be regarded as investment research or a J.P. Morgan investment research report.
