The Week Ahead – The Conundrum of Cash

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

Cash. What to do with it. The latest online search reveals that most major national banks are offering a scorching 0.01% for checking and savings accounts. CDs aren’t offering much more, a 7-month CD offering up 0.05% (which is the same rate for a 37-month CD!). Online banks are offering higher rates at about 0.50%. Still, not all that attractive considering inflation (CPI) over the last year through July clocked in at +5.4%. For some, cash has been a safe refuge from volatile equity markets. However, over time inflation can eat away one’s purchasing power. Our team often looks at the 10-year U.S. Treasury as the so called “risk free rate,” a risk free investment backed by the full faith and credit of the United States. At the close of last Friday that 10-year U.S. Treasury was yielding 1.29%. The 10-year U.S. Treasury has actually been on a downward trend since the early 1980s when it peaked at 15.84% after then Fed Chair Paul Volker raised the Fed Funds rate to battle inflation.

Companies face the same conundrum as capital allocators. They want their cash working for them at all times. During the past year many companies have taken advantage of the low interest rate environment to build war chests of cash to survive the Covid-19 crisis. The Fed went as far as backstopping investment grade rate companies last year via the Primary Market Corporate Credit Facility to prevent a liquidity event during the crisis. With the recovery well on its way now, many companies are still sitting on those war chests of cash and now face tough decisions: de-lever their balance sheet by retiring debt, buy back equity shares, make an acquisition, or spend it on capital expenditures. There has been a surge in corporate buyback announcements so far, with $683 billion in announced plans for share repurchases through the end of July. The last time we saw a greater number by companies was back in 2018 in the wake of federal tax cuts. We’ve seen some companies announce new acquisitions. Capital expenditures has been extremely strong as companies begin to reshape themselves for a post Covid-19 world. Typically capex recoveries take about three years on average to return to pre-recession levels. For the Covid-19 recession it took an astounding six months.

Now back to inflation, mentions of “inflation” jumped to a record high this earnings season by companies during their earnings calls. Much of it was focused on labor (hiring back workers) and supply chains (continued disruption on the backlog of orders and transportation). We agree with the Fed that inflation should be transitory as the economy begins to normalize over the next 12-18 months. But what does that mean for investors? In the past we’ve talked about re-calibrating and one difficult recalibration has been on cash and interest rates. Holding cash feels safe but that safety is at the cost of future purchasing power getting eroded away by inflation.

In the week ahead investors will get a chance to review the latest Fed Meeting Minutes and to get a grasp on the timing for the tapering timeline.

Data deck for August 16–August 19