Why are many people afraid to invest economically?
Unused cash? Invest in heated markets
Fear of high valuations and high volatility, investors have amassed record amounts of unused cash. In the short term, however, security has its price. With clearly defined long-term goals, investors can invest this money with confidence despite the uncertainty about the economic recovery.
When the markets crashed in early 2020, many investors turned their holdings into cash. During the subsequent upswing, however, only relatively little money flowed back into the markets. According to Morningstar data, inflows into global money market funds totaled more than $ 978 billion net in 2020, outperforming the past decade and inflows into equity and bond funds (see Illustration). Despite some cash outflows in the second half of the year, money market assets surged to a record $ 6.24 trillion in 2020.
In uncertain times, having cash is comforting. It provides a safety buffer against worrying volatility spikes such as we've seen many times during the rebound over the past year. When interest rates are at a record low, as they are at the moment, and even negative interest rates prevail in many developed markets, there is almost no income from cash. So those investors who stay away from the market pay high opportunity costs. At the same time, the steepening US Treasury yield curve in early February 2021 is seen as a sign of stronger economic growth and higher corporate profits.
High ratings don't always lead to disaster
For many investors, the high valuations are an argument against investing the cash - and especially against investing in US stocks, which reached new record highs in early February. However, our research now shows that stocks have delivered solid returns over time, including for investors who entered the market when stocks were already looking relatively expensive.
For example, the S&P 500 has climbed to or almost a record high in 43 percent of all months since 1950 (see Illustration). And those who would have invested the same amount on every market high should look forward to an average annual return of 9.6 percent. That's 1.9 percent less than the return that would have been made on any given investment at any time in the market, but we think it's a solid result over time.
High ratings don't always lead to disaster. However, current valuations have emerged from extraordinary market trends, adding additional concern to investors. The rising price and earnings valuations in the US stock market are primarily due to the rise in stock prices and not to earnings growth. In other words, expecting the global recovery to generate corporate returns, investors have pushed stock prices higher.
It would be too much to ask for a real recovery to take place. We believe it is unlikely that returns across the market will rise at the same time as there is still uncertainty about how each country will recover from the pandemic and how quickly the recovery process will take place. Many industries also face business challenges. So investing in ETFs for passive, low-cost market exposure may not be the best way to reinvest cash and take advantage of the recovery potential.
Find the right systems with three questions
We therefore think that investors should rather consider a wide range of active options that suit their personal needs, risk tolerance and personal market views. The following three questions can help you find the right investment options (see Illustration):
1. Is your investment horizon long-term or short-term?
2. Do your investments have to be liquid or can you accept illiquidity?
3. Do you prefer conformist options, or do you like to invest in disliked, less-in-demand assets that may offer better valuations?
If you're taking a shorter-term approach, consider liquid stocks and bond funds. Investing in growth stocks was particularly successful and popular in 2020, but this is the market with the most severe valuation problems. High-yield bonds offer access to an asset class that tends to be unrelated to equities, have a lower downside risk and also offer higher potential returns than the broader bond market.
Investors willing to go against the tide should consider more non-conformist portfolios. For example, at the end of 2020 there were signs of life from value stocks with below-average performance. If the economic recovery accelerates, they could see a stronger upswing. Value stocks are trading at a growth discount that's higher than it has been since the tech bubble 20 years ago. Non-US stocks and small caps also performed well over the past year, often offering more attractive valuations than their US counterparts.
For investors with a longer-term approach, more illiquid options may be considered. These could include private equity portfolios and hedge funds, which have become consensus alternatives in recent years. Non-conformist options such as secured assets or corporate bonds would also be conceivable. These possibilities all benefit from a different flow of returns and at the same time tie up the fund for a longer period of time, which avoids the volatility fluctuations associated with traditional investments in publicly accessible markets.
Better to invest
Although there is likely to be a point in time this year when the trend is bearish, given the macro situation and the amount of cash available, we assume that such a correction will not be very deep. Over time, most asset classes are likely to outperform cash, especially at current rates. And since it is next to impossible to correctly predict the timing of the market turning points, we think it better to be invested in the market - even in today's volatile market conditions. With risk-conscious and active investment approaches, investors can reinvest their cash holdings with conviction and thus use a diverse, selective return potential, although there is still uncertainty about the future.
Scott Krauthamer is Global Head of Product Management and Strategy at AB
Opinions expressed in this document do not constitute analysis, investment advice or trading recommendations, do not necessarily reflect the views of all of AB's portfolio management teams, and are subject to change from time to time.
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