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The Saturday Soloinvestor

#2

Decoding the Rationale: Why Cash has Transformed from 'Trash' to 'Good' in Current Perspectives

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Over the past few months, my stance on the attractiveness of cash has shifted, prompting inquiries from individuals keen on understanding the rationale behind this change. Contrary to my statement in early 2020 that "cash is trash," I now assert that "cash is pretty good," a sentiment fueled by the prevailing interest rate dynamics.

In essence, my observations on the appeal of cash hinge on the interest rates available during specific periods. In 2020, when interest rates were meager (below 1 percent, in Europe minus), cash seemed less appealing, earning the "trashy" label. However, in the recent context, with interest rates around 5 1/2 percent (In the US and EU 4 3/4), cash has become notably attractive for me.

The fluctuating nature of cash's attractiveness stems from a comprehensive evaluation involving several criteria, which I aim to elucidate to empower you to make informed decisions rather than providing prescriptive conclusions.

Primarily, my assessment of cash's appeal revolves around:

 

  1. Real interest rates concerning prospective inflation rates.

  2. Federal Reserve indications of tightening or easing based on inflation and growth.

  3. Relative attractiveness of expected cash return compared to other investments.

  4. The supply-demand dynamics for cash and bonds.

 

While my actual methodology is more intricate, I will outline a simplified yet effective approach.

When considering lending (investment) in cash:

a) Favorable conditions include rising interest rates and a risk-free interest rate exceeding 1 percent above the inflation rate.

b) The real interest rate should match or surpass the economy's real growth rate.

Conversely, borrowing (shorting cash) is preferable when the opposite conditions prevail.

It's crucial to note that these benchmarks pertain to risk-free (US Treasury) rates, with riskier debt demanding higher interest rates. Currently, I find cash appealing, particularly in the overnight to two-year maturity range, as it offers a satisfactory rate without risking principal loss.

In contrast, I avoid longer-term bonds (10 years or more) due to potential price declines during rate hikes.

 

I look for a 1 1/2 to 2 percent rate above prospective inflation or a real interest rate surpassing the prospective real growth rate for considering bonds. External factors, such as supply and demand dynamics, also influence my estimates.

As for stocks, my analysis involves intricate assessments of individual companies' earnings, dividend yields, and growth prospects.

 

In a simplified view, the stock market currently indicates a 5-5 1/2 percent expected return, which appears low relative to bond yields now.

In conclusion, while these calculations lack precision, extreme differences in prospective returns prompt action. Cash, with its attractive return and minimal price risk, stands out, serving as a prudent option amidst uncertainties. I trust this insight provides a comprehensive understanding of my thought process in navigating these financial considerations.

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