Cody on RM: The Competition From Cash

The Competition From Cash
07/12/2006 9:26 AM EDT

I got ramblin', I got ramblin' all on my mind
Hate to leave my baby, but you treats me so unkind -- Robert Johnson

Monday night I was at dinner with one of my partners. We were talking about his investments, his career and how he (and others) manages his overall portfolio.

Eventually we started talking about his investment in a bunch of high-yield trusts and high-yield preferred stocks that he'd put a bunch of money into a couple years ago, when he'd sold his apartment in New York City for a big gain. He'd grown increasingly leery of the real estate market and rents an apartment in the city now as he still has no interest in real estate.

Most of those high-yield assets are in energy-related vehicles, so we started talking about the blow-off top in commodities and how energy has hung pretty tough during this meltdown. He said he felt like he'd been lucky because he has 20% of his assets in these investments. I said, "Whoa, 20%! Nice job and all, but should you take something off the table?" He answered, "Yeah, I suppose I should, but dammit, Cody, it's hard to walk away from an average of about an 8% yield on these things."

And that's when it hit me, and I pointed out to both of us at once: Hey, you know what? Cash yields more than 5% in some places right now -- 5%!

Now, 5% ain't 8%. But cash is cash, man, and unless the fiat U.S. dollar and the society we've built on it collapse tomorrow, cash is as just about as safe an investment as you can have in this world right now. Those energy trusts and preferreds and other assets and whatnot that yield 8% are decidedly not cash. Every investment in any company comes with fraud risk, options-backdating risk, execution risk and all kinds of other risks.

So my friend turns to me and says, "Hmm, I think I'm going to sell some of that high-yield stuff and park it in some cash."

That is a real-life example of what it means when someone points out that the higher yields of cash are starting to compete for investment dollars. Indeed, my buddy's capital has flowed out of the system from which we finance growth and investment in this capitalistic society. It's now drawing 5% while sitting idle in cash.

In the last couple of years, depending on your starting point, while the yield on cash has been sprinting to 5%, the S&P 500 has been mostly rangebound and essentially flat, yielding capital appreciation and dividends of about 5% or a little more. You don't think investors look at the yield and safety of cash and wonder why they're dealing with all the stresses and risks in the market? They do.

Maybe it all will reverse and maybe the Fed will cut rates because the governors end up deciding they did take things too far after all. Maybe the market will take off in a huge rally, and the returns on stocks will suck everyone back in.

I do think the stock market is a much better place to be in the intermediate and long term than cash. But we can't analyze the attractiveness of stocks in a vacuum. Because there are indeed other asset classes competing for our money. And one of those is safe ol' cash and its 5% yield.

So, for right now I still prefer to be in cash, as I have been for the last couple months, during which time cash has yielded about 1% while the markets have, well, melted down.