"If you hold too much cash in your portfolio, that could potentially come with some risks," says Matthew Diczok, head of Fixed Income Strategy, Chief Investment Office, Merrill and Bank of America Private Bank. That's especially true now that the Federal Reserve has begun to cut interest rates.
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On-screen copy:
Chris Hyzy
Chief Investment Officer
Merrill and Bank of America Private Bank
On-screen disclosure:
Please read important information at the end of this program. Recorded on 9/19/2024.
[Chris Hyzy speaking]
Hello and welcome. The recent larger than expected rate cut by the Federal Reserve has signaled a whole new ballgame for the markets and the economy. Today, we'll explore how this move might impact strategies for managing cash in a declining interest rate environment. Over the past several years, rising rates have provided investors with exceptionally high returns on cash. But with the Fed's latest rate cut, the first since 2020, many are wondering what's next.
[Chris Hyzy speaking]
Is cash the place to be as rates continue to go lower throughout this year and potentially next? Or, should they be thinking about how to move excess cash into other assets? And what's the longer-term role for cash in a balanced portfolio? To help us explore these topics, I'm joined by Matt Diczok, Head of our Fixed Income Strategy for the Chief Investment Office.
[Chris Hyzy speaking]
Matt, welcome.
[Matthew Diczok speaking]
Thanks for having me, Chris.
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First Fed interest rate cut since 2020 was 50 basis points
[Chris Hyzy speaking]
Let's get into it. 50 basis point cut. I want to ask you first: before the 50 basis point cut, which is the first in four years since 2020. What was the thought a few weeks ago and what changed about 24 hours before the actual cut.
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Matthew Diczok
Head of Fixed Income Strategy, Chief Investment Office
Merrill and Bank of America Private Bank of America
[Matthew Diczok speaking]
Thought a few weeks ago was only 25. But clearly what Powell sees now is inflation has come down dramatically. Employment is slowing and really inflation is not a problem. But they really don't want a recession. So, about a week or two ago they started thinking 50 might be more appropriate, get jump started with a larger cut, to show the market that they're serious about protecting the economy, protecting employment, keeping the labor market in good shape.
[Chris Hyzy speaking]
He used the word many, many times in the press conference: recalibration, something that we've talked about a lot. We've talked about recalibration. We've talked about rebalancing, maybe rates going back to the 1990s-type of yield curve? Explain to everybody about what he means by "recalibrating." And then as we're talking about rates coming down, what does that actually mean, first, for the fixed income market.
[Matthew Diczok speaking]
So, we had inflation at about 9%, right? And they got the Fed funds rate to just over 5% to deal with that. But now inflation is around 3% or below. So, you don't need to have the same rate you had when inflation was at this 9% to bring it back down. They need to recalibrate. Bring it to a more normalized level.
[Matthew Diczok speaking]
So start at 50 and then continue to bring it down slowly, again, to protect the economy. What that generally means, short rates are probably going to come down, possibly relatively quickly. So if you're in cash, which is not fixed income, we like to say it's variable income. The rate changes on that very quickly as the Fed changes rates. You're not protected from those rate changes.
[Matthew Diczok speaking]
So, what they really should consider, do they want reliable and predictable income over time? Because if you extend out in bonds, whether it's 3, 4 or 5 years, whatever is appropriate for the client, then you can have a good idea over that time frame what you can earn.
[Chris Hyzy speaking]
Try to lock in that higher yield.
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Lock In higher yields for predictable, reliable income over time.
[Matthew Diczok speaking]
You're trying to lock in that higher yield. But again, if you stay in cash, you don't know. It might be higher tomorrow, it might be lower. Again, our prediction is they're going to be lower significantly so over the next 18 months. So it's less about trying to get a better return. It's more about getting a predictable return. If you know what your bills are, if you know what you have to spend, if you extend out and lock in those yields now, you can sort of protect yourself against declining interest rates and remove that, what we call, reinvestment risk.
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Focus on predictable returns in the near future.
[Chris Hyzy speaking]
It's a good point. It's another R-word, "reinvestment risk." So the Fed chair says recalibrate. We're going to recalibrate, too, as it relates to how we think about the fixed income markets and invest around it. As it relates to excess cash,
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Holding too much cash could have risks.
[Chris Hyzy speaking]
If you hold too much cash relative to your portfolio strategy, that could also potentially come with some risks.
[Matthew Diczok speaking]
Absolutely. Over longer periods of time, cash generally gives you a return like inflation, meaning that you actually don't grow real wealth with cash, usually just keep pace with price growth. If you want to get a return over inflation, don't think about cash. Cash is really a safety asset. You need to be in the market. That includes fixed income, includes equities, alternative investments for qualified clients.
[Matthew Diczok speaking]
If you're not in the market, you're not going to get above inflation-returns, likely. Cash won't give you that. Over longer periods of time, cash, generally, significantly underperformed other risk assets, which actually makes it risky over a long-term investing time horizon.
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If you're not in the market, then you're not going to get above-inflation returns.
[Chris Hyzy speaking]
What should people consider in things like equities?
[Matthew Diczok speaking]
Well, generally speaking, we are more favorable in equities at the moment. We are slightly overweight equities as you know, because, again, we feel the economy is in good shape. Like you said it's normalizing from excessive inflation, excessive employment, excessive price growth, excessive economic growth. It's normalized to a more normal level. But it doesn't seem to be slowing. It doesn't seem pre-recessionary.
[Matthew Diczok speaking]
But even if it did seem that way, the Fed has a lot of room to cut. Rates are still in the high 4%. They still have a lot to do. So the Fed is very attuned to economic risk. That means macroeconomic risk for us is less of a concern right now. So we favor equities. We favor, in particular, U.S. equities versus the rest of the world, still at this moment.
[Chris Hyzy speaking]
What about within the equity markets? You see a rebalancing coming. We've talked about this before. It's clear that tech was leading for many, many years, but leading significantly in the last couple of years, overall. And its high market cap way in the S&P 500, people were worried about over time.
[Matthew Diczok speaking]
Definitely a rebalancing. No one sector is going to continue to outperform for years and years and years on end. So the first thing we want folks to do is be diversified across sectors, not try to chase any sector's outperformance, tech or otherwise. And that also can be some sectors like financials have become more favorable recently. That might do better as the fed lowers rates.
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Diversify among sectors.
Don't chase outperformance in any sector.
[Matthew Diczok speaking]
And make sure you're diversified. And, again, look for opportunities to spread out your risk among different sectors.
[Chris Hyzy speaking]
Dividends going to make up a good portion of returns, potentially in the next few years?
[Matthew Diczok speaking]
Historically, dividends do make up a good portion of equity returns, so it makes sense to have not just growth stocks that have, you know, a potentially higher price appreciation but less dividends, have a balance between growth between some sectors, that actually pay more dividends, give you more cash over time.
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Consider dividend-paying stocks.
[Chris Hyzy speaking]
Two words of the day recalibration, rebalance. You also said another one: reinvestment risk. Thanks for joining me, Matt.
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Recalibration, rebalance, reinvestment risk.
[Matthew Diczok speaking]
Thanks, Chris.
[Chris Hyzy speaking]
I hope this has given you a better idea of current rates, where they may be headed and some ways to manage your cash for the months to come. We'll keep you posted on new developments. And from a long-term perspective, I hope you found this conversation helpful and understanding the important role cash plays in your portfolio, not as a risk-free place to hide during volatility, but as a working part of a well-balanced strategy designed to pursue your goals.
[Chris Hyzy speaking]
Thank you for watching.
On-screen disclaimers:
Important Disclosures
The opinions expressed are as of 9/19/2024 and are subject to change.
Investing involves risk, including the possible loss of principal. Past performance is no guarantee of future results.
Alternative investments are intended for qualified investors only. Some or all alternative investment programs may not be in the best interest of certain investors. No assurance can be given that any alternative investment's investment objectives will be achieved.
Asset allocation, diversification, and rebalancing do not ensure a profit or protect against loss in declining markets.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Dividend payments are not guaranteed and are paid only when declared by an issuer's board of directors. The amount of a dividend payment, if any, can vary over time. Investments in a certain industry or sector may pose additional risk due to lack of diversification and sector concentration. Bonds are subject to interest rate, inflation and credit risks. Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice-versa.
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In the video above, he and Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank, offer tips to help you adjust your asset allocation in this lower rate environment. They also discuss what's behind the cut, how many more might follow and the potential impact on the economy, markets and investors' portfolios.