Cash makes a comeback as asset owners brace for correction
“Sell in May and go away” is one of the oldest maxims of equity market investors - the idea that it's better to consolidate your position ahead of the mid-year doldrums and return to the market fray later in the year.
Signs have begun emerging this month that institutions have indeed positioned themselves to take some money off the table, as listed equities in developed and emerging markets continue to perform strongly.
Research by Bank of America for the first week of May shows a sizeable shift to cash, to the tune of $57.3 billion in one week. This is the largest move since March 2020, when the outbreak of Covid-19 caused a major market panic and the S&P 500 index lost a quarter of its value.
Some funds have already made such moves. Australia's Future Fund, for example, has had a cash weighting of around 20% for some time, in part over a concern that value is hard to find in listed equities.
"One year on, equity markets are now at their peaks again and pricing in expectations of a strong economic recovery," Lim Chow Kiat, chief executive of Singapore sovereign fund GIC, said in a statement posted on the fund's website.
Investors have been pushing up the price of listed stocks, particularly technology stocks. The S&P 500 posted 12-month returns of over 54% through March 2021, which was the third highest 12-month return on record since 1936.
“Investors have ridden the equity market because there was very little else to choose from, in that bonds were far more expensive than equities,” said Alex Zaika, managing director for Australia at fund manager GAM.
Despite the seemingly obvious overshoot in fair value displayed by the S&P, Credit Suisse recently adjusted its forecast for the year, adding another 10% upside to the index. By contrast, Bank Of America has predicted an 8% drop from current levels.
GIC also senses that a reversion to the mean is more than likely.
"Recent policy stimulus has lifted asset prices to levels where investors risk overpaying and suffering permanent impairment," observed Lim.
RISING BOND YIELDS
Added to which, he said rising bond yields can be expected to reduce the value of companies’ future cash flows.
"Rising bond yields and inflation have caused concerns about overheating and potential monetary tightening."
Michael Wyrsch, chief investment officer at Melbourne-based VisionSuper, said his fund has more cash than usual because it has less fixed income than usual. “We retain a decent allocation to equities because it still looks to have better prospects,” he told AsianInvestor.
”Economic conditions look pretty good and company earnings have been strong. I guess we think there are parts of the equity markets that are better value than others.”
Bank of America recommends buying cyclical stocks and small-cap companies over large-caps and stocks that hinge on strong GDP and an expansion in capital expenditures.
Wyrsch acknowledges that “there are a few storm clouds on the horizon,” but the fund is not overly concerned.
Similarly, Unisuper’s CIO John Pearce said, “We have been taking some profit, but nothing too significant.”
The rally in risk assets is not surprising, he added, given the largely positive earnings reports coming out of the US and the fact that nominal GDP growth is set to boom. “And central banks have repeatedly stated that they will not be hiking rates until they hit their inflation targets and full employment.”
The big test for markets will be "how they react when we experience a quarter or two of high inflation prints," Pearce told AsianInvestor.
“Current expectations are that the market will see it as transitory, but I’m not so sure," he noted. "It’s hard to see US 10-year bond yields trading at 1.5% if inflation is printing at 4%.”
With global interest rates at 140-year lows, growing political divides and corporate and public debt levels set to climb even higher, it will be very difficult to calibrate or withdraw these massive stimulus measures, predicts Lim.
"This introduces policy risks for inflation and currencies that investors have not had to contend with in recent history."
PRIVATE ASSETS DEMAND 'INSATIABLE'
Insurers do not generally make tactical portfolio shifts, or try to time markets.
At Prudential Life in Thailand, head of investment, Yingyong Chiaravutthi said he looked to a rising level of bank deposits, growth of money market funds and short-term government bond yields as key indicators: “But I don’t see much movement there. Perhaps people are de-risking and looking for good quality assets, but not cash yet,” he told AsianInvestor.
The longer term challenge for asset owners is that, despite their recent increase, bond yields are still very low, and a lot of the equity markets are still trading at fairly high valuations. Lim said this forces GIC to conclude that “returns for a typical 60/40 equity/bond portfolio over the next 10 years will be significantly weaker than their historical returns over the last 30 to 40 years”.
But he said “finding an alternative hedge to bonds is still a challenge, as most assets do not have the scale that bond markets offer.”
Where their portfolio constraints allow, some institutions are now implementing equity portfolio hedges, as option pricing has become more affordable, with implied volatility levels falling, Zaika told AsianInvestor.
He added that the demand for private assets is "insatiable".
"This is particularly true for private debt across institutions. I’m seeing much stronger interest in late-stage private companies from the high-net-wealth segment. Companies are staying private for longer as they have better access to private capital and they avoid the additional regulatory requirements of being a listed company. I expect this trend to continue."
This article has been edited to correct GIC's Lim Chow Kiat's title and statement source.