The Federal Reserve, and central bankers around the world, have engaged in a vast experiment. Collectively, they've pushed interest rates toward zero, or below, in some cases. This has had major ramifications for investors, pushing up the price of reliable dividend paying stocks like Procter & Gamble (NYSE:PG) or once relatively high-yielding payers like Realty Income (NYSE:O). That could change quickly if safety suddenly becomes more desirable than risk.
What's a banker to do…
The main goal of the Fed's low rates is pretty simple--make cash an undesirable investment. In effect, the bank pushed rates to the point where holding cash was so bad financially that there was no other choice but to find a better place to put that money to work. There's a trickle down effect here, though.
For example, if you don't hold cash but still want a relatively safe investment, where do you go? High quality bonds of some sort. But as investors move away from cash and into bonds, then bond prices go up and yields go down. Bonds, then, become undesirable, too. The next stop is stocks.
The big push starts in higher yielding companies known for their regular and reliable dividends. Which helps explain why Realty Income's yield is hovering around its all time lows. This company not only pays a monthly dividend, but it also has a multi-decade history of regular increases--most of which have occurred on a quarterly basis. There's no question that Realty Income is a great company with a storied history, but it isn't a bond. And with a valuation at such an extreme the risk is that investors are overpaying for what has become a more meager yield.
And that pushes investors into lower yielding fare. For example, Procter & Gamble's stock price is hovering near all time highs despite the fact that this consumer products company has been struggling through a period of corporate adjustment. To sum it up, it got too big and tried to push too hard into new markets. That didn't work so it's slimming down and refocusing around core brands. It's not a bad company, or a bad plan, but the struggles it's dealing with are notable and probably warrant more caution than investors appear to be taking. Investors have been willing to ignore the risks because Procter & Gamble has reliably paid a growing dividend and offers an above market yield.
This is exactly the type of risk seeking that the Federal Reserve and central bankers around the world want. Why? Because it pushes investors away from cash and toward putting their money to work. If no one wants cash, then anyone who gets cash will try to pivot back toward other investments. In this way, the bankers hope, we'll see investment in the economy that will drive growth.
I like cash
But what if holding cash is no longer seen as a bad thing? For example, according to Bloomberg asset managers have started to let cash pile up in their portfolios. The move isn't huge, on average cash is in the 5% to 6% range, but cash is at its highest level in years. Higher than when the United Kingdom was voting to leave the EU and higher than after the 2007 to 2009 recession. The only time this century that cash was at a higher level was after 9/11.
Following that article up was another about Mohamed El-Erian, of PIMCO fame. He's let cash rise to a massive 30% of his portfolio. This is just one person and the cash is part of a very specific investment strategy, but when you put it together with the fund managers noted above, it starts to suggest that cash isn't as unloved as it once was.
Now you have to ask, "If investors start to actually like cash again, what happens?" The answer is the trend reverses. Investors start to shift away from riskier assets and increasingly put their money into boring old, and safe, cash. That reduces demand for stocks like Procter & Gamble and Realty Income. It reduces demand for high yield bonds and less exotic fixed income securities. With lower demand you start to see lower prices. There's just no one there to buy, at least not at the prices being asked.
Falling into the void
That, in turn, leaves a void between the growth and value camps. Broadly speaking these are the two driving forces in the market. Since value guys only want to own stocks at bargain prices, they've been left out of the market for some time. In fact, prices are so extreme in some cases that it will require notable price drops before value guys are interested in stocks.
So there's a large divide between growth and value... And that means stocks have to move notably lower before the value investors will be willing to provide a floor. That's where you see quick and extreme market declines. The broad market decline at the start of this year, for example. Note that REITs have recently seen another swift retreat, too.
Watch the gap
I've been allowing cash to pile up in my portfolio for some time. It's easily my largest single position at this point. I'm not ready to put that money to work, there's just nothing I see that's cheap enough. I'm in the value camp. I'm just one person, but from the comments on my articles I know I'm not alone. If investors get spooked by something, anything, and they decide they want out of riskier assets--there will likely be very few people to step in to buy at current levels.
That could lead to swift and steep declines. And if the scare is big enough, those drop offs could start to pile up on each other. In other words, it won't be a 10% correction and a recovery, it will be a 10% drop that gets followed by another drop, and another, and another… until the market is down by 50%. If you doubt that's possible, go back and look at the 2007 to 2009 recession and the internet bubble.
The increasing desirability of cash is just one more piece of evidence that all is not well on Wall Street. Don't change your life based on this one data point, but don't ignore it either. Alone it doesn't tell a story, but added to the list of concerns I have it is telling. For me, I'm going to be paying a lot more attention to the other investors who are starting to like cash as much as I do. When enough of the crowd loves cash, it will be time for me to start looking for bargains. The market will probably be much lower by then, though.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.