Tuesday 20 March 2018

Best January since 1990s is sign investors are willing to play risk game once again

James Saft

EQUITIES have had, by some measures, their best January in more than a decade. Signs point to cash coming off of the sidelines as an important supporting factor.

Global stocks are up almost 5pc for the month and the Standard & Poor's 500 Index posted its best January since 1997.

Meanwhile, flows of money into equity funds and ETFs have been strong, while cash has drained out of major banks and money market accounts.

Central banks have worked hard for the past four years to entice worried investors and businesses to put their cash back to work, but with only limited success.

Central banks have cut rates while at the same time buying up assets, especially government debt. The net result is very low deposit or short-term rates.

Therefore, if you are an investor and have a bond mature, or are sitting on cash, you are paying a pretty hefty premium in lost purchasing power.

The cost of that premium can be measured by looking at what you would earn in a Treasury bill minus the purchasing power you lose to inflation.

The three-year rolling return on that is a loss of more than 5pc, according to Andrew Lapthorne, quantitative analyst at Societe Generale in London.

To put it in perspective, returns from cash are worse than in the last similar period when cash was punished – the 1970s – when high inflation meant cash almost literally rotted in your hands.

Ray Dalio, founder and chief investment officer at $142bn (€105bn) hedge fund Bridgewater Associates, thinks a move out of cash into a range of assets, including equities, is going to be a force in 2013.

"We're in a situation where risks are reduced. So the fear, the desire to hold that cash is reduced. You can go out on the risk spectrum," Dalio told CNBC in Davos, Switzerland, recently.

Investors may simply have thrown up their hands, and concluded that the risks of losing slowly and surely in cash are greater than that of another downturn.

Investors in US-based equity mutual funds and ETFs have ploughed more than $29bn into the sector in the first three weeks of January, according to Lipper data, including a massive week ending January 9 which qualifies as the fourth-best on record.

Money has also been flowing into bond funds, indicating that people discounting the "great rotation" out of bonds and into stocks may be getting ahead of themselves.

Money market funds, however, are seeing money leaving, according to both Lipper and Investment Company Institute data.

What's more, there is intriguing evidence that deposit money is flowing out of the largest banks, some of which may well be finding its way into stocks.

Deposits at the 25 largest US lenders fell by $114bn, or almost 5pc, to $5.37 trillion in the week ending January 9, according to Federal Reserve data, in what Barclays Capital says is the biggest such outflow since just after the September 11 attacks in 2001.

This could have been driven by the December 31 end of an FDIC programme to insure deposits over $250,000.

One other interesting possibility is that money is finding its way into stocks because investors are putting to work money paid out prematurely in dividends and bonuses at the end of 2012.

Many companies brought forward disbursements to beat an anticipated 2013 tax hike, helping to drive personal income up 2.6pc in the month. If so, that argues for the rally and the flows to be short lived.

Cash flowing into stocks, if that is what is happening, is an important and powerful force, especially if it is part of a broader willingness by investors and companies to take on risk.

These things can become self-fulfiling – and not simply because stock prices going up make people feel wealthier and spend more.

But the rally doesn't tell you anything about the value of the market. Stocks are not terribly expensive when you look at earnings, but risky if you worry about growth. This might simply be a momentum market, one which goes up because it is going up.

One of the clear risks of very loose interest rate policy is that it can feed financial bubbles. That happened in 2000 and again several years later. Bubble or not, a cash-fuelled rally could be the theme of 2013.

Irish Independent

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