According to analysts at Wells Fargo, it may be time for investors to make important decisions about their alternative cash allocations and positions in fixed income as the Federal Reserve begins a policy easing campaign.
In a note to clients, analysts said the cash move has provided investors with a steady stream of interest while avoiding volatility in the bond market since the Fed began raising interest rates to more than two-decade highs in 2022. Cash investments may come with lower levels of risk, although usually with lower returns.
However, they highlighted two risks surrounding continuing a cash-centric strategy in the current trading environment.
First, those with an outsized cash position face reinvestment risk, or the possibility of missing out on the opportunity to reinvest future cash flows at the current rate of return, analysts said.
A second risk revolves around money market funds becoming a “cash lever” for a longer period of time, they said. The term refers to holding part of a portfolio in cash instead of investing it in the market.
“Over time, riskier assets have outperformed cash and cash alternatives,” they wrote. “Our long-term study of capital market assumptions shows that US stocks have beaten cash returns […]. The strength of compounding yields has generally benefited riskier assets such as stocks, while leaving cash at a disadvantage […]’.
As a result, they warned investors to avoid cash as a long-term investment strategy or significant allocation.
Instead, they recommended allocating cash across asset classes, adding that this focus on diversification offers a “mix of growth potential and risk management provisions,” particularly for “investors with a strategic time horizon.”
Analysts argued that with uncertainty surrounding both the Fed’s policy plans and the outcome of the US presidential election, portfolios should emphasize quality – particularly large-caps over small- and mid-caps.
Recent volatility in equity markets, meanwhile, should push investors into sectors such as communications services, energy, financials, industrials and materials and reduce positions in sectors such as consumer staples, basic consumer goods, real estate and utilities, they added.
Elsewhere, bond investors should expect short-term investment to fall alongside additional expected rate cuts from the Fed before the end of 2024. The central bank already cut borrowing costs by 50 basis points last week .
“[T]he relatively high returns that investors have enjoyed over the past two years in high-quality short-term investments will decline,” Wells Fargo analysts said.
“On the other hand, moving to longer durations to lock in higher yields exposes investors to significant market price swings and potential losses should the economy pick up again and long-dated yields move higher next year.”
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Reference;
Kanowsky, S. (2024) Why Wells Fargo says investors have key decisions to make amid Fed easing cycle By Investing.com, Investing.com. Investing.com. Available at: https://www.investing.com/news/stock-market-news/why-wells-fargo-says-investors-have-key-decisions-to-make-amid-fed-easing-cycle-3636930 (Accessed: 28 September 2024).
