August 29, 2022: Cash Is King

Aug 30, 2022 | Feature, Newsletter

Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Thursday September 1, 2022. 

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Cash Is King

It didn’t take long for markets to revert back down and now it looks like the recent stock market rally is a bear market rally. In this newsletter on July 18, 2022, we stated that ultra short term Treasury bonds are now a viable alternative to both stocks and bonds. Indeed, other than commodities, nothing has delivered positive returns recently. See the following trend score table (from 360° Market Overview).

As of 08/26/2022

Description Symbol 1 Week 4 Weeks 52 Weeks Trend Score
Commodities DBC 2.58% 1.99% 38.7% 9.71%
Treasury Bills SHV 0.03% 0.24% 0.27% 0.26%
Municipal Bonds MUB -0.67% -1.88% -7.43% -3.09%
US High Yield Bonds JNK -1.57% -1.55% -6.24% -3.39%
Mortgage Back Bonds MBB -0.72% -2.54% -8.15% -3.42%
Total US Bonds BND -0.4% -1.84% -9.53% -3.72%
US Credit Bonds IGIB -0.54% -1.94% -10.64% -4.1%
Gold GLD -0.59% -1.43% -4.95% -4.35%
Intermediate Treasuries IEF -0.5% -2.71% -10.81% -4.41%
US Equity REITs VNQ -3.92% -3.38% -7.07% -4.75%
US Stocks VTI -3.79% -1.2% -10.87% -4.82%
Emerging Market Stks VWO 0.51% 1.09% -16.4% -5.95%
Emerging Mkt Bonds PCY 0.17% -0.04% -22.45% -7.73%
International Developed Stks VEA -2.79% -4.24% -16.06% -8.66%
International Treasury Bonds BWX -1.27% -4.37% -22.52% -10.37%
International REITs RWX -3.27% -6.37% -21.14% -11.97%

Notice that US Bonds (BND) had -9.5% 52-week loss, almost as large as -10.9% 52-week loss of US stocks (VTI). No wonder it’s been moaned that nothing worked so far. We will discuss a bit more later on current market conditions. For now, let’s move on to look at the most boring yet more and more important asset: cash.

Cash Is King

We want to first make some quick comments on why cash is important these days.

First, as what was illustrated in the above and commented many times in our newsletters, we believe that cash will be the only major viable asset for a while as current inflationary period will last for some time. In this period, inflation pressure will be high and the Federal Reserve is forced to keep raising interest rates (or just like what Chairman Powell said last Friday: ‘We must keep at it’) until inflation comes down. Unfortunately, it does increasingly look like we are in a long period of high inflation as major economical (such as de-globalization) and geopolitical (such as the friction between the west and the east) secular trend changes. Interested readers can see May 9, 2022: The Secular Market Cycle Change for more detailed discussion. In such a period, both stocks and bonds will come under pressure to deliver reasonable (or even positive) returns (see August 1, 2022: What We Can Learn From 1970s And 1980s). Furthermore, beware that in this type of periods, interest rates can fluctuate wildly, creating some deception that we are back to the old deflationary or low interest rate environment, only to see another period of high inflation.

Second, as odd as it might sound, ultra short term bonds or cash might be able to deliver some respectable returns in such a period as interest rates increase. Though we are not saying that short term interest rates will be as high as double digits like in 1970s to 1980s, it gets very reasonable to have your cash to return like 3% to 5% in the coming months and a year or so, at least.

Third, cash is the important anchor asset in a risk asset (both stocks and bonds) market stress like the one we are in right now. Being in cash temporary allows us to avoid large loss and get back to other assets later on to capture some big gains. Some investors are anxious and impatient on low cash returns in their portfolios and many are quick to forget that some of best returns in history happen when markets recover from a bear market. Patience is the virtue and cash is king for now.

Current short term cash-like returns

The following table shows what one can get in a brokerage like Vanguard through Treasury bills (Treasury debts that are mature within a year) and brokered CDs (see July 13, 2020: Short Term Cash, Treasury Bills, CDs And Future Fixed Income for discussion on these investments):

Unfortunately, our latest spot check on major banks such as Bank of America and Chase still shows 0.1% or so interest rates for most checking and savings accounts.

On the other hand, brokerage money market funds are offering some better yields these days:

As expected, brokerage money market funds have better yields than those banks, but still lower than what you could get from purchasing Treasury bills directly in a brokerage:

Money Market Fund 7-Day SEC Yield
Vanguard Federal Money Mkt 2.13%
Fidelity Government Money Mkt 1.47%
Schwab Government Money Mkt 1.88%
Etrade Sweep Rates or JP Morgan US Government Money market fund (available to its personalized investment clients) up to 0.15% (sweep), JP Morgan (1.15%)
Vanguard Prime Money Mkt No longer offered
Fidelity Money Mkt 1.68%
Schwab Prime Money Mkt 2.2%

What the above tells us is that it’s much better off to purchase 1-3 month mature Treasuries by yourself from brokerage accounts than being paid through some brokerage money market funds. Of course, it’s absolutely a loser if you just let your cash sit in a major bank account, getting a fraction of 1% interests!

This is, of course, only being possible if you know how to use and can stand the unbelievably archaic bond/CD trading interfaces in those brokerages to buy and sell Treasury bills or CDs. We’ll have some detailed walk through in our future newsletters on this. For now, we encourage you to at least give a trial in your brokerages such as Schwab, Vanguard, Etrade, TD Ameritrade etc.

Finally, as Fed Fund rates (they are usually directly related to short term interest rates) are expected to rise to 3% to 4% in 2023, we can expect cash will pay more as time goes.

MyPlanIQ ultra short term bond ETF portfolio

This brings us to review our ‘money market fund equivalent’ ETF portfolio MPIQ Ultra ST Bond ETFs:

Portfolio Performance Comparison
Ticker/Portfolio Name YTD
Return**		 1Yr AR 3Yr AR 5Yr AR Max Draw Down
MPIQ Ultra ST Bond ETFs 0.3% 0.3% 1.0% 1.6% 0.5%
CASH (CASH) 0.5% 0.5% 0.4% 0.7% 0%
NEAR (iShares Short Maturity Bond ETF) -0.0% 0.1% 0.9% 1.5% 9.6%
ICSH (iShares Ultra Short-Term Bond ETF) 0.3% 0.5% 1.1% 1.6% 3.9%
TFLO (iShares Treasury Floating Rate Bond ETF) 1.0% 1.0% 0.7% 1.2% 0.2%
BIL (SPDR Barclays 1-3 Month T-Bill ETF) 0.5% 0.5% 0.5% 1.0% 0.2%

Five-year chart:

Just to recall that the portfolio dynamically chooses an ETF from ultra short term bond ETFs like NEAR, ICSH, TFLO, BIL in the table to invest once a month.

Some observations:

  • This ‘money market’ portfolio avoided a big dip earlier this year. Its maximum drawdown is 0.5%, just bordered on the requirement for a fund to be a money market fund (a money market fund’s NAV (Net Asset Value) needs to be maintained within 0.995 to 1.005).
  • In comparison, ICSH and NEAR had -0.9% and -0.4% maximum drawdown in the last 12 months. Furthermore, both funds had much bigger maximum drawdowns (-9.6% and -3.9%) during the 2020 market rout. Their volatility disqualifies them to be money market funds as some have tried to do.
  • The portfolio has outperformed all of the above in the last 5 years.
  • Candidate funds like NEAR (iShares Short Maturity Bond ETF) has a 30-day EC yield as high as 2.79%. Furthermore, its average yield to maturity is 3.83%. We expect these funds to deliver higher yields than Treasury bills (3 month maturity) as time goes. When markets are again in better conditions, we believe our portfolio will switch to these funds to gain higher yields.
  • Finally, TFLO (iShares Treasury Floating Rate Bond ETF)  is an interesting Treasury ETF that invests in Floating rate Treasury bills that has effective duration 0.01 yr. The floating rate Treasuries try to deliver a yield as close as the 3-month maturity Treasury bills. In our opinion, this is the closest ETF that can be used in place of a Treasury money market fund such as Fidelity Government Money Mkt or Etrade sweep cash.

Market overview

Fed chairman Powell did exactly what we expected last Friday in his Jackson Hole Economic Symposium Speech: he declared that the Fed will continue to hike interest rates until inflation comes down. We said in our previous newsletter:

If ‘Don’t fight the Fed’ worked in the past, it would be wise this time around to stick to this. As the main purpose of the Fed’s raising interest rates is to tighten financial conditions, part of which are controlling elevated stock and other asset prices, at best, stock prices will stagnate.

It’s thus no surprise that both stocks and bonds experienced large loss last week. All risk assets other than commodities are in downtrend.

It’s worth to point out that currently economic indicators are actually not decisively bearish. In fact, retail sales are now back to year over year positive growth while industrial production is still growing. However, with interest rates increasing (30 year mortgage rates are now as high as 6.6%), housing activity is more and more negatively affected. High interest rates will eventually filter through other parts of segments, eventually slow down demand. Whether this will be a just right ‘soft’ landing or an undershoot ‘hard’ landing is still yet to be seen. Markets are swayed back and forth to try to guess. For now, markets are leaning to a bearish view.

At the moment, we call for patience and stay the course. Our strategies will respond to market and economic conditions as time goes:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or preferably much longer given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation has dropped. However, it is still high by historical standard. For the moment, we believe it’s prudent to be extra cautious. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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