[Investing] Three reasons to seize the current opportunity and make good use of cash for investment

Main points

• Cash underperforms in 2023. Looking back, the average return on a multi-asset portfolio was three times the return on cash, whether interest rates were low or high.
• As major central banks end their rate hike cycle, the cumulative returns from holding cash over any relevant period will not be sufficient to compare with current annualized yield levels.
• Markets are forward-looking and generally rebound before interest rate cuts. It’s smart to invest your cash through a multi-asset portfolio to diversify risk while maximizing potential returns.

With interest rates expected to fall amid the prospect of lower inflation and slower growth, investors should reassess the appeal of a high cash rate. Looking back, the average return on a multi-asset portfolio was three times the return on cash, whether interest rates were low or high. We propose three major reasons to seize the current opportunity and make good use of your cash for investment.

1. Cash returns are lower relative to other asset classes

Broad markets did outperform cash in 2023. Cash returns of around 5% may look attractive compared to cash returns between the global financial crisis and the COVID-19 recession, but the actual opportunity cost of cash will also depend on the relative performance of other assets, and these performance in 2023 Years are particularly prominent. Furthermore, with consumer prices rising by about 3.5% in 2023, the nominal yield on cash only translates into a real return of 1.5%.

As the cash rate is a fundamental component of all asset returns, a rise in the cash rate will increase long-term expected total returns across all markets, including stocks, bonds and alternative investments. Additionally, rising risk premiums in government bonds and equity markets in 2023 increase their growth potential. It is important that investors should not focus solely on evaluating individual investment opportunities (such as cash), but should evaluate and compare other opportunities and consider expected real returns, not just nominal returns.

2. Major central banks complete their interest rate hike cycle

Another important factor is that the interest rate hike cycle has ended. At the time of writing, analysts, markets and central bankers do not expect further rate hikes at current levels. Money market futures show that the United States and the Eurozone will cut interest rates about 6 times before January 2025, each with an amplitude of about 0.25%, and we expect the interest rate cuts to begin in mid-2024. This means that the cumulative returns from holding cash over any relevant period are insufficient to compare with current annualized yield levels.

Figure 2: Expectations of interest rate cuts become a market driver and cash returns will begin to decline

3. Markets tend to rebound before interest rate cuts

Finally, let us look at the historical data related to the first interest rate cut immediately after the end of the interest rate hike cycle. As shown in Figure 3, in the eight months before the first interest rate cut, the average total return in both the stock and bond markets was 8-9%, far exceeding the return on cash. Markets are forward-looking and they tend to rally in anticipation of rate cuts, and this is especially true for bonds.

Figure 3: Most of the rally occurred before the first rate cut, especially in bond markets

Overall, we think stock and bond markets will significantly outperform cash in the year leading up to the first rate cut, as they have in past cycles. A multi-asset portfolio, especially one that includes alternative investments such as hedge funds, private equity and commodities, can help maximize potential returns while diversifying risk.