‘Cash is trash,’ Dalio said. ‘Get out of cash. There’s still a lot of money in cash.’
CNBC, 21 January 2020
For those who are not familiar with Ray Dalio, he’s the founder of the world’s largest hedge fund firm, Bridgewater Associates.
Forbes puts Dalio’s net worth at US$19 billion.
He’s seriously wealthy and seriously smart.
‘‘‘Everybody is missing out, so everybody wants to get in,” Dalio said on CNBC’s ’Squawk Box’ at the World Economic Forum in Davos, Switzerland.’
What does Dalio think everyone whose missing out should do (emphasis added)?
‘… he [Dalio] thinks investors shouldn’t miss out on the strength of the current market and that they should dump cash for a diversified portfolio.
‘Dalio advised having a global and well-diversified portfolio in this market and said the thing people can’t “jump into” is cash.’
His advice could not be more emphatic…get out of cash and into a well-diversified portfolio.
And Dalio is not the only one making the case for ‘cash is trash’.
In The Australian on Tuesday, 28 January, 2020 there was an article titled ‘Cashed-up SMSFs need to find a better balance’.
The author of the article is a senior personal finance writer with Vanguard Investments Australia.
To quote (emphasis added):
‘The average return from cash was 1.5 per cent in 2019, a far cry from the impressive returns above 20 per cent achieved by various index funds invested in Australian and international shares. Even bonds, an asset class that generally delivers lower returns given its lower risk profile, on average generated returns close to 10 per cent.’
The writer’s solution for those with money in the bank?
‘Broad diversification to offset risks across asset classes is one of the critical elements of every investment strategy.
‘Diversified exposures to different types of investment assets, including products tilted towards lower-risk assets, have significantly outperformed cash over the long term.’
The writer and Ray Dalio are singing from the same hymn sheet.
There will still be a lot of money in cash
They present an open and shut case on why cash is trash and should be withdrawn and invested in a diversified portfolio.
Possibly, a diversified portfolio that’s managed by Bridgewater Associates and/or Vanguard, just saying.
In the investing world, sometimes all is not what it seems to be.
Those with vested interests can and do talk their own book…albeit in a subtle and instructive manner.
Ray Dalio’s comment ‘there’s still a lot of money in cash’ is supported by the data.
Here’s the broader definition of what constitutes ‘cash’:
‘M2 is a measure of the money supply that includes cash, checking deposits, and easily convertible near money.’
Ray Dalio is US-centric, so we’ll look at just how much M2 cash is in the US of A?
Source: Federal Reserve Economic Data
As you can see, there’s a lot of money in cash (or, cash equivalents).
More than US$15 trillion to be precise.
Dalio’s advice to those holding these trillions of dollars?
‘Get out of cash’.
‘…should dump cash for a diversified portfolio’.
On face value, with cash rates falling and markets rising, you can see why Dalio’s message gains a lot of traction.
That creaking you can hear right about now, is me crawling out on a limb with ‘but, what Ray Dalio said was silly…really silly.’
And here’s why.
The markets for shares, property, bonds and precious metals (a diversified portfolio of assets) operate on the principle of ‘willing buyer and willing seller’.
Let’s say those holding the US$15 trillion in cash have a Damascus moment and are converted by Dalio’s ‘get out of cash’ and ‘dump cash’ sermon.
The converts are now willing buyers…eager to get out of cash for a portfolio of diversified assets.
To do so, they need to enter into a contracted exchange with willing sellers — those holding the diversified assets.
Let’s say that happens.
In return for agreeing to sell their assets, the willing sellers will receive…guess what…cash.
That US$15 trillion in cash simply moves from one bank account another…the M2 line on the FRED chart remains unmoved.
There is no cliff face drop in the chart as the money leaves the system.
Because as quickly as it leaves one account (the willing buyer’s), it’s deposited into another account (the willing seller’s).
The end result of all this buying and selling activity?
There will still be…a lot of money in cash.
It’s absolute nonsense to suggest the thing people can’t ‘jump into’ is cash.
Because whenever a contract is settled, one party jumps out of cash and the other jumps into cash.
Diversified or concentrated?
‘Don’t have all your eggs in one basket’ makes the concept of diversification an easy sell for the investment industry.
But what if diversification is not all that it seems to be?
What if diversification actually means exposing your money to greater risks?
In the latest version of my book How Much Bull Can Investors Bear? I debunk the myth of ‘broad diversification to offset risks across asset classes is one of the critical elements of every investment strategy’.
This is from Chapter 11:
These days a diversified fund might look something like the pie graph below.
You think you’re investing in a wagon wheel of supposedly uncorrelated assets.
Source: 720 Global
In fact, what you are actually buying into is this:
Source: 720 Global
Diversification amounts to nought if the capital behind those asset classes can be traced back to a single denominator…QE, zero interest rates and the chase for yield.
Central banks have floated all boats higher…with one exception. You guessed it…cash.
In a time passed, diversification actually meant you offset risks by having the traditional portfolio of 1/3rd shares; 1/3rd property; 1/3rd fixed interest.
Not these days.
As luck would have it, the writer of The Australian article actually provides the evidence to debunk the diversification theory.
The writer states:
‘…the impressive returns above 20 per cent achieved by various index funds invested in Australian and international shares.’
A couple of things here.
Firstly, those impressive returns are what has happened, not necessarily what’s going to happen.
Unless you were invested in that asset class at that time, those returns are meaningless.
Secondly, in October 2019, the IMF reported…
‘The global economy is in a synchronized slowdown and we are, once again, downgrading growth for 2019 to 3 percent, its slowest pace since the global financial crisis.’
With slowing global economic activity, why did shares — an asset class that over the long term delivers between 8% to 10% per annum — achieve an annual return that’s more than double the historical average?
Do you think it could have anything to do with artificial supports…like the Fed pumping US$500 billion into the repo market and lowering interest rates?
And, then the writer goes onto state…
‘…bonds… an asset class that generally delivers lower returns …on average generated returns close to 10 per cent.’
The following table shows the range of interest rates offered on 10-year government bonds by a variety of countries.
Source: Trading Economics
Do you notice anything?
Not one of the major countries — US, UK, Germany, Japan and even, Australia — are paying interest rates anywhere near the average generated returns close to 10%.
So how is a near double-digit return possible from such low single-digit rates?
Bond markets are — to the outsider — a back-to-front proposition.
For existing bondholders, if rates go lower the bond is worth more and if rates go higher, the bond is worth less.
How much higher or lower depends on the duration (term) of the bond and the extent of the interest rate movement.
To help clarify, here’s the difference in interest earned between a 10-year bond paying 1.75% and 0.75%.
Source: Trading Economics
If the 10-year rate falls from 1.75% to 0.75%, the holder of the higher paying bond now has an income stream (paying an extra $100k over the life of the bond) that can be sold in the bond market for more than its $1 million face value.
How much more does that 1% rate change make?
Source: CMG Investment Research
The table shows the value increases by around 9.6%.
Here’s how bonds generate those impressive returns…
Interest rate of 1.75% PLUS capital gain of 9.6% = 11.35%
What did the US 10-year rate do in 2019?
Glad you asked…it fell around 1%.
Source: Trading Economics
And that’s how you can get a low rate fixed interest investment paying high rate returns.
Again, we have another asset class — fixed interest — that’s been floated higher by central banks suppressing interest rates.
However, what happens if/when there’s a spate of corporate and/or sovereign defaults?
The market panics and demands higher rates.
Remember, when rates rise, bond values fall.
What will be the extent of the losses?
Take a look at the right-hand side of the bond return table…the one with the red circles.
Depending upon how high rates go and the duration of the bond (10-year or 30-year), losses could be up to 44% or higher.
And finally, what about property?
Do you think capital city property prices would be anywhere near current nosebleed levels if the RBA had not taken our rates to historically low levels?
Shares. Fixed interest. Property. They’ve all been floated higher by central bank manipulation.
In the days before central banks actively meddled in market pricing, diversification was once a sensible strategy for spreading risk.
But that’s no longer the case.
Based on my estimates, here’s a range for the possible losses within a diversified portfolio…
Shares — 65% to 80%
Property — 30% to 50%
Bonds — 10% to 45%
Risks exist right across the asset spectrum…with one exception. Cash. This is the only asset class that has NOT been floated higher by central banks.
What those associated with the industry (the ones who obsess over performance figures) forget, is that for some people it’s NOT about return ON capital.
For some, it’s about return OF capital…especially at a time when valuations — in all asset classes — have been stretched to historical levels.
Something will eventually snap and when it does, those who thought a diversified portfolio would minimise risk, will be in for a very nasty surprise.