In today’s newsletter we take a look at some of the thoughts around cash. When is cash king and when is it not? With some rather gloomy days in the past week we have a few investment thoughts and comments on the not so pretty economic environment.
The cash and the king
In times of uncertainty and in times of change there is a flight to safety and a flight to quality. Across the globe, investors have passed on pure equity investments and there is an abundance of money sitting in cash and money market funds. Given the returns of last year this is of course hardly surprising. Cash has become safe, it has become a preserver and it has become a favoured asset class. The asset class with the least amount of risk.
Is it always true that cash has the least amount of risk?
Cash and the credit crunch
The credit crunch – where so many global consumers spent – using credit and often house equity – and the banking crisis where some banks were leveraged very highly – saw capital dry up. No longer is it possible to lend at cheap rates, and for many it is not possible to lend at all. Businesses are now in the driving seat if they have a solid balance sheet – with some cash – and the countries with cash are also in a much more favourable position. So here, cash is very much king. Credit, while by no measure as available as it was prior the crisis, is however, available to those who can afford it.
It is also true that if you run a business the ability of your customers to pay becomes critical. PwC conducted a business insights survey of private companies in October last year and available cash flow was one of the three most highlighted financial indicators. Effective cash collections was also highlighted and PwC Director Andries Brink expects this to rise in importance.
The same holds true for individuals. Perhaps sometimes we need to think like a business to depersonalise our attitudes to money. If cash is king for a business (any size business) and cash flow is critical –it is also true for the individual.
Cash on your personal balance sheet and in the bank – vital. This is of course not new and for many years leading experts have emphasised the importance of three months living expenses in cash as a cushion, and of course for those unexpected emergencies.
Cash the king for investors?
Is cash an investment?
To grow wealth and capital and provide for a future need, an investment needs to grow at a rate that exceeds inflation. This should be the first benchmark for an investment. Otherwise you are effectively going backwards. Inflation eats into capital and erodes wealth, and a good investment needs to, over time, deal with this and build wealth. (and our inflation is still quite high.)
Over the long term, cash has given far lower returns.
However, it is a fallacy that you need to be invested all the time. Sometimes you need to park. This is according to Paolo Senatore, Head of Portfolio Management at RMB Private Bank. But there’s a but.
BUT – “don’t throw away the keys.” That money has to find a home eventually.
Cash may be king right now for preservation – but is it meeting a long term need – and for how long has it been parked?
With credit scarcity, low confidence levels and uncertainty cash still holds much positive sway. But of all the asset classes it is probably the one that demands the most frequent review.
Making our way through
Kokkie Kooyman, Global Fund Manager at Sanlam Investment Management says that while it is difficult to say, we are probably 75% through the crisis, with another 6 months to go. But he says the turnaround will be slow and could take around two to three years.
One of the key things that had to happen to ‘normalise’ the financial system, was the deleveraging among banks. Kooyman says this is happening big time overseas in countries like the US, UK and Spain. Kooyman says that South Africa is very sheltered from this process. In many countries a lot of transactions were done with leverage and the deleveraging is happening at a very fast pace – as banks seek capital, credit becomes scarce and credit lines are being frozen. Kooyman says that over the last eight years banks were doing very leveraged transactions – and so a much smaller percentage of loans needed to go bad to have an effect on depositers and shareholders.
While we may be more than half of the way through the crisis a major factor remains the low level of confidence. “Confidence has been totally shaken.”
An economy can grow when people are prepared to invest and put up new money, but confidence is so low now that it may be a while before we see new investment.
The crisis as a time of change
Recession is not a new word. It started receiving press mentions over a year ago. We have indeed had recessions before, this one is just particularly tough coming after such a boom for our country and our economy. And it is tough because it is global. Is it different this time?
Investment Solutions Global CIO, Glenn Silverman, says that most fund managers’ frame of reference is at most the last 20 or 30 years, and we are yet to realise just how fundamentally the current crisis will change the way people view and treat money.
Unlike the 1929 crisis – where credit was frozen completely, doing everything possible now to keep credit lines open may well just be prolonging the agony.
Silverman uses the analogy of a ‘hangover’ – in 1929 the world economy, drunk on credit, was sobered up by freezing credit.
This time around, central banks the world over have scrambled to save lending institutions and keep credit supplied to a credit dependent world. By fighting to keep the supply of credit flowing globally the hangover is being treated with more booze.
Silverman believes that “this may prolong the crisis making the final, inevitable, headache even more severe – and taking even longer to sober up.”
“When excess money is printed, as is happening now, it is impossible to know exactly where it will end up. For example, easy credit in the late 1990’s found its way into the technology sector. When that bubble burst, credit moved into the Western residential housing market, and then into the commodity arena. Each new credit-driven cycle was built on the back of the previous one. The punch bowl was never removed and the hangover never allowed to wear off over time.”
“This time around when the penny dropped, arguably on the back of the sub-prime crisis and the bankruptcy of Lehman Brothers, the global economy effectively suffered a massive heart attack” says Silverman.
He argues that “we are now entering a painful period of right-sizing with global markets re-setting to a new, lower level – one far less supported by credit. As such a new age of thrift may be upon us.”
In the face of this view, attempts to artificially sustain credit in economies with neither growth nor yield may prove both costly and futile – with the potential to saddle economies with public sector debt for generations to come. As such instead of predicting an imminent recovery (though bear market rallies, even spectacular ones, are to be expected), Silverman argues that “the world is more likely to see a secular bear market for, say, the next three to five years – something unseen for some time.”
And the lessons learned in the process may be so large that the generations immediately following ours are likely develop an entirely different attitude to money, investment and growth.
“Savings and thrift will, again, become a central feature of wealth management. Returns on investment may remain low for years to come. Greed will no longer be seen as good. The enormous bonuses and payouts to CEOs, bankers and fund managers will be a thing of the past. And, in the West, it may be a full generation before people again assume excess credit” says Silverman.
Since easy credit and its associated lapses in practice also reached South Africa’s shores we are certainly not immune. That said, the levels of indebtedness reached in South Africa and hence the adjustments now required, are less dramatic.
“South Africa climbed on to the credit bandwagon later than most developed economies and the National Credit Act did slow things down a fair bit. That said, given South Africa’s appetite for credit there is little doubt that had credit been available here on easy terms for say another five years, South Africa may well have ended up in the same boat as the United States, the United Kingdom or Australia” says Silverman.
Even though resources have taken a knock in South Africa the local economy is still showing growth – with lower interest rates, rising gold prices and any true resolution of the situation in Zimbabwe offering potential for even more growth.
As such Silverman believes that “while South Africa will flirt with recession, it is unlikely that the country will go into the minus four and five percent GDP numbers that many economies in the developed world may see.”
Instead, South Africa will continue to offer both yield and growth at a time when developed economies are offering neither. “That should, hopefully, ensure that capital continues to flow in to South Africa, portending a better outcome and quicker turn around than in many developed economies” says Silverman.
Because there has been so much change and innovation, and because we have significantly increased the speed at which we live, work and play, it is almost as if this difficult time is taking too long. It may well take time, patience and endurance to see it through.
The danger of being left behind
Be wary of putting too much on hold in tough times.
As many should be wary of spending too much time with too much in cash, so too be wary of being left behind during a down cycle. If you are a business, developments will happen in your industry at all times. Stopping any new development can have the disastrous consequence of coming out of the downswing as a laggard rather than a leader. Of course funds and capital are always an issue. But life does not stop because we are in a period of no/low/slow growth. Ideas do not stop. Sometimes they flourish. If businesses are able to adapt and innovate in easy times, the good businesses will find ways to adapt in challenging times.
Can you follow this principle with your finances? Your future needs are not put on hold because the markets are volatile. Because economies are not growing. If you put your investment and risk needs on hold will you have the ability to play catch up when things turn?
The best chance you have of achieving investment goals happens if you start young. The stats are just scary of how much you need to invest in your later years to play catch up with an investor who had a head start at age 20. Trying to play catch up in your forties may mean it is all you will be playing.
The same thing happens with cover. If risk products are to provide cover for your assets and unexpected events, then would it make sense to forgo this cover when times are more uncertain and more expensive? If you forgo cover – while catch up may not be the right word, it may well be more expensive when it is resumed. And there may be more onerous requirements to meet to get the cover you then need. If you forgo risk cover, then you ultimately transfer the risk onto yourself. Is that affordable?
By all means run lean and run mean, but be wary of putting too much on hold – it can cost in the long term.
The comments and opinion in this newsletter are comments and opinion only and do not constitute financial advice. It is of the utmost importance to take any financial decision in accordance with a well constructed and unique financial plan with the input of a professional financial adviser.