2023-11-06 08:15:50
(Photo credits: DR – )
By Kevin Thozet, member of the Carmignac investment committee
Source: Carmignac, Bloomberg. Diversified portfolio: 60% S&P 500 and 40% 10-year Treasury bond. Monetary: 3-month cash instrument. Data from October 2023.
Over the past two years, cash and other short-term financial instruments have generated strong performance, superior to that of a diversified portfolio composed of both stocks and bonds (in the graph, the gray areas correspond to the periods when cash outperforms a diversified portfolio) in an environment that offered few safe havens to investors, with bonds going through the worst bear market (1) in history.
Moreover, this phenomenon seems to have contributed to the success of the latest calls for national savings launched by various European states (2). But if, as we can now say, holding cash has once proven to be more advantageous than investing in stocks and bonds, it is rarely wise to rely solely on past data to prejudge what will be the future.
Opportunity or importunity?
It is true that liquidity provides a welcome refuge, particularly in times of stagflation (3). However, choosing the right time to disinvest or reinvest in the stock markets is not easy. If history is any guide, it would be better to invest in a diversified portfolio including both stocks and bonds – including when money market and other short-term instruments show equivalent – or even higher – returns. to those that can be found on the stock and sovereign or corporate bond markets.
Although it may be tempting to secure returns of 4% in euros (or 5% in dollars) via money market funds or other term accounts, any rational investor will prefer to look further than the undeniable carry4 offered by these short-term instruments. Indeed, if returns are what we are aiming for, then other segments and asset classes offer much better opportunities.
On the bond markets, we can seek to benefit from both the carry and price components, especially since the probable end of the monetary tightening cycle both in the euro zone and in the United States is accompanied by a risk of reinvestment (5) increased. Therefore, it appears possible to benefit from both the attractive yield currently offered by the bond markets and the future fall in rates (which, all things being equal, will have a positive impact on bond prices).
On the stock markets, it is important to prepare for more difficult times, which could result from an environment of slowed growth, or from an even more stagflationary context where inflation is more likely to surprise on the rise, as growth declines. Beyond the delicate art of “timing”, the so-called “barbell” approach seems best suited to this problem. It consists of investing both in stocks and sectors (6) which will benefit from persistent inflation and/or more outspoken stimulus measures in China, and in defensive sectors or securities (7).
In any case, cash is far from being the solution. They can, however, be part of it, by reducing short-term risk and, when uncertainty subsides, by facilitating the arbitrage of our investments towards segments more promising for a “barbell” strategy.
(1) Over the last three years, a 10-year US Treasury bond has lost as much as the S&P 500 stock index between its peak and trough at the height of the Covid crisis. Over the same period, a 30-year US Treasury bond lost as much as the S&P 500 stock index between its peak and trough at the height of the 2007-2008 financial crisis.
(2) The BTP Valore (Italy) and Van Peteghem (Belgium) bond issues each made it possible to raise nearly 20 billion euros in the space of a few days.
(3) Stagflation: economic situation characterized by the simultaneous occurrence of low growth and high inflation.
(4) Carry: potential gain resulting from holding a bond after deducting financing costs.
(5) Reinvestment risk: possibility that an investor will be unable to reinvest the coupons or interest received on an investment at an equivalent rate.
(6) Gold, energy, materials, Japan, China.
(7) Health, quality values, sector leaders.
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