Investors long patience, or cash, are finally benefiting from asset inflation. As buoyant markets and low volatility allow the Federal Reserve to begin its normalization process, interest rates on cash and cash equivalents are on the rise. The three month T-Bill is yielding 1% while various savings accounts and cash equivalents are providing yields slightly over 1%. It’s not much, but for investors waiting for higher returns on their savings, patience is finally beginning to pay (side note: it may be a good time to check yields on cash to make sure you’re not getting shortchanged).
We’re in an interesting part of the market cycle for stocks and bonds. For most of this cycle, stocks and bonds have simultaneously enjoyed the wonders of 0% interest rates and central bank asset purchases. Things are changing. While I question the perception that the Federal Reserve has turned “hawkish” (short-term real rates remain negative), as long as financial conditions remain stable and equity prices inflated, the Fed will most likely continue raising rates. In effect, until something in the financial markets “breaks”, the Fed’s tightening path appears to be on a set course. Remember, they want to be transparent, predictable, and avoid sudden shifts in policy.
As stated in a recent post, the Fed’s plan to gradually raise rates reminds me of Greenspan’s attempt to exit from his extended period of easy money. During the second half of the Greenspan-Bernanke cycle (2002-2008), monetary policy was tightened consistently until the stock market crashed and the U.S. economy entered a severe recession. Is the Fed on a similar late-cycle path today? If so, I believe it’s possible patient investors will be rewarded regardless of whether stocks rise or fall.
Exactly when the current market cycle ends remains unclear, but in my opinion, the cozy relationship between short-term interest rates and equities is over. Going forward, higher stock prices will most likely lead to higher short-term rates. This changing relationship could be a win-win for patient investors. For instance, if stock prices remain inflated, I expect the Fed will continue to raise rates, giving patient investors a higher return on their cash. Alternatively, if higher rates cause the market cycle to end abruptly, patient investors would benefit from the avoidance of capital losses and lower stock prices.
While I continue to miss out on the all-too-easy gains in the stock market, I remain committed to my absolute return discipline and its requirement to remain patient during periods of overvaluation. Waiting isn’t easy, but with short-term interest rates trending upward, it’s gotten a little easier. As the later stages of the current market cycle unfolds, I believe patient investors will likely be rewarded with either higher returns on their liquidity or a more attractive opportunity set. After years of punishing 0% returns on cash and few genuine discounts to value in equities, I view both outcomes as refreshing and potentially very rewarding.
Please keep those rate increases coming!