Investors wondering whether markets can continue their torrid rally are eyeing one important factor that could boost assets: a nearly US$6 trillion pile of cash on the sidelines.
Soaring yields have pulled cash into money markets and other short-term instruments, as many investors chose to collect income in the ultra-safe vehicles while they awaited the outcome of the Federal Reserve’s battle against surging inflation. Total money market fund assets hit a record US$5.9 trillion on Dec. 6, according to data from the Investment Company Institute.
The Fed’s unexpected dovish pivot on Wednesday may have upended that calculus: If borrowing costs fall in 2024, yields will likely drop alongside them. That could push some investors to deploy cash into stocks and other risky investments, while others rush to lock in yields in longer-term bonds.
Cash has returned an average of 4.5% in the year following the last rate hike of a cycle by the Fed, while U.S. equities have jumped 24.3% and investment grade debt by 13.6%, according to BlackRock data going back to 1995.
“We are getting calls ... from clients who have a significant level of cash and are realizing they need to do something with it,” said Charles Lemonides, portfolio manager of hedge fund ValueWorks LLC. “This is the beginning of a cycle that will start to feed on itself.”
Recent market action shows the scramble to recalibrate portfolios may have already kicked off. Benchmark 10-year Treasury yields, which move inversely to bond prices, have fallen around 24 basis points since Wednesday’s Fed meeting to 3.9153%, the lowest since late July.
The S&P 500 is up 1.6% since Wednesday’s Fed decision and stands less than 2% below a record high. The index is up nearly 23% this year.
“If you think the Fed is done with the hiking cycle, then it’s time to deploy cash as the opportunity is there,” said Flavio Carpenzano, fixed-income investment director at Capital Group.
Not all the cash in money market funds may be available as “dry powder” to be invested in stocks and bonds. Some of it is held by institutions that might otherwise have that money in bank deposits and is needed for cash purposes, said Peter Crane, president of Crane Data, which tracks money market funds.
History also shows that the bulk of cash in money markets tends to remain even as rates come down, said Adam Turnquist, chief technical strategist for LPL Financial.
“I think you could start to see some flows come out of money markets and chase this rally, but I don’t think we are going to see anything to the tune of a trillion dollars or some massive flows that some people might expect,” Turnquist said.
And while money market assets are at record highs, their size relative to the S&P 500 is smaller than it has been during past peaks.
Total money market fund assets as a percentage of market capitalization stand at about 15.5%, in line with the long-term median and well below the record high of 64% hit in 2009 in the aftermath of the global financial crisis.
For now, however, investors’ appetite for risk has been easy to spot. In the options market, for example, traders are spurning protection from a near-term drop in stocks even though the price of such hedges is attractive from a historical standpoint. The Cboe Volatility Index, which reflects demand for insurance against market swings, fell to pre-pandemic lows this month.
“No one is interested in buying insurance,” said Chris Murphy, co-head of derivative strategy at Susquehanna Financial Group, noting that the low level of defensive positioning leaves the market vulnerable to a sharp reversal in the event of an unforeseen negative shock.
Indeed, the sharp rebound in equities from their October lows has made some investors wary that markets have risen too quickly.
“There’s enough money out there that it doesn’t take a lot to directionally move the markets higher,” said Jason Draho, head of asset allocation, Americas, at UBS Global Wealth Management.
Still, the swift gains over the past six weeks in both equities and stocks “makes you a little concerned about where the upside is from here for the markets overall,” he said.
-- Reuters
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Stocks to ponder
Coveo Solutions Inc. (CVO-T) In November of 2021, this small-cap stock was listed on the Toronto Stock Exchange – just before central banks began raising interest rates and tech stocks tumbled. The initial public offering price was $15, but the share price closed below $5 by May of 2022. The share price has rebounded to nearly $10, and analysts see much more upside ahead for the stock. As Jennifer Dowty tells us, the company is a play on artificial intelligence that has attracted some big-name institutional investors.
The Rundown
Markets outpace central banks as rate cut bets fuel ‘everything rally’
Markets have raced ahead of the U.S., euro zone and UK central banks to price in sizeable and frenetic interest rate cuts next year, fuelling a so-called everything rally that could now be vulnerable to a correction. The U.S. Federal Reserve on Wednesday signaled it would cut rates more than previously outlined, sending global stocks and bond prices surging as markets priced in six quarter-point rate cuts in 2024, double the number projected by Fed officials.
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Ask Globe Investor
Question: What method does The Globe and Mail use to calculate five-year dividend growth rates shown on its website? How often is the number updated? In some cases, I cannot make sense of these figures. One example is Timbercreek Financial Corp. TF-T, which is shown as having 15-per-cent dividend growth but which doesn’t appear to have raised its dividend in more than five years and has not had a stock split.
Answer: As you’ve discovered, not all dividend data you find online can be trusted, so today I’ll show you how to calculate these numbers yourself so you can verify their accuracy.
Five-year dividend growth rates are available in a couple of places on The Globe website. For individual companies, if you call up a stock quote and click on the “Dividends” tab, you will see a table of numbers that includes dividend growth, yield and the company’s upcoming dividend payment date. To find dividend growth rates for multiple companies, open your stock Watchlist, click on the “Dividends” view and look under the column labelled “5-YR GRW”.
As far as I have been able to determine, this metric measures the compound annual dividend growth rate for the five-year period up to and including the most recent full calendar year. So, if you’re looking at a company’s dividend growth rate today, it will include data only to end of 2022, as there are still a couple of weeks left in 2023.
To understand how these growth rates are calculated, let’s look at a specific example. We’ll use Capital Power Corp. (CPX), one of the stocks in my model Yield Hog Dividend Growth Portfolio.
According to Capital Power’s website, in 2017 the Edmonton-based power producer declared dividends totalling $1.615 per share. The company raised its dividend in each of the following five years, and by 2022 its annual payout had grown to $2.255, representing total growth of about 39.6 per cent. (Divide $2.255 by $1.615, subtract 1, then multiply by 100 to get the percentage change.)
Now, the question is: What does growth of 39.6 per cent over five years work out to on a compound annual basis? We’ll need to do a little more math to find out.
If a dividend grows by 39.6 per cent over five years, that’s the same as multiplying the starting dividend by 139.6 per cent, or 1.396. To convert that last number into an annualized figure, you’ll need to calculate the fifth root of 1.396. This is the number that, when raised to the power of five, equals 1.396. Thanks to the magic of Google, you can simply enter “What is the fifth root of 1.396?” into your search engine and get the answer: 1.069. (Or you could use a calculator with an nth root function.)
We’re almost there. The final step is to subtract 1, which leaves us with 0.069, or 6.9 per cent. Voilà: We’ve just calculated Capital Power’s five-year dividend growth rate.
Good news: it exactly matches the five-year dividend growth rate for Capital Power provided on the Globe website.
Now, the bad news: dividend growth rates published online aren’t always so accurate.
Timbercreek Financial is a case in point. If you visit the investor relations section of the company’s website and call up its “Dividend History”, you’ll see that the monthly payout hasn’t changed since at least 2017. So the true five-year growth rate is zero, not 15 per cent.
It’s not just The Globe that got this one wrong. I also checked TMX Money and Morningstar (which provides dividend growth data to The Globe) and found similar mistakes. That’s why I always advise people to go directly to the source instead of relying on third-party websites for financial data.
Another thing you wouldn’t know about Timbercreek without checking its website: Its “dividends” are actually 100-per-cent interest (with a tiny amount of capital gains in 2018). Interest distributions are taxed at one’s full marginal rate in a non-registered account and do not qualify for the dividend tax credit. That could be a deal-breaker for some investors.
Now that you know how to calculate dividend growth rates yourself, you can verify that the numbers you find online are accurate. Just remember that, while a history of dividend increases is often a sign of a great company, it’s not the only metric you should look at when evaluating a stock. Sales and earnings growth, valuation and the company’s competitive “moat,” among other factors, are also important considerations.
--John Heinzl (E-mail your questions to jheinzl@globeandmail.com.)
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Compiled by Globe Investor Staff