What caught my eye this week.
Sorry guys, I am up against it this evening so no devastating hot take preamble from me today.
As ever though, thoughtful responses on the articles featured this week are more than welcome in the comments.
Have a great weekend!
Some Monevator readers question why they should bother owning bonds in their portfolio when they can earn higher yields with cash. They make a good point.
A competitive three-year fixed rate savings account bags you a 1.3% interest rate right now. Whup-whup!
Think that’s overenthusiastic? Well, a rate of 1.3% is positively Epicurean compared to the shoeing you can expect for offering your money to the bond market:
If you compare the duration of any gilt ETF against the same length maturity on the FT’s Bond Yields table, you’ll see that the ETF’s YTM approximately matches the yield shown on the table.
Capiche? A gilt ETF is no more than the sum of its underlying gilts, after all.
That leaves our three-year cash option 1.4% ahead of its gilt equivalents. In cash terms, you’ll earn an extra £1,400 in interest per year for every £100,000 you have tucked away at that interest rate.
Meanwhile, taking on more interest rate risk does not look worth it – even 30-year gilts yield only 0.68%. As carrots go that reward is shaped like a particularly hideous load of old genitals.
And if you’re worried about inflation then the market is saying: “Don’t bother your head.”
Let’s say interest rates rise by 1%. That doesn’t seem likely any decade soon but bear with me.
Your old gilts immediately drop in price. That’s because their scrawny interest rates are forced to compete with the pumped-up coupons of shiny new bonds, which parade around the market like bodybuilders on Venice beach.
Our three-year gilt and short-term gilt ETF would fall about 3% in price to remain attractive to buyers. (As per the duration of 3 mentioned earlier).1
The three-year savings account would also drop its pants by about 3%, if there was an open market in fixed-rate savings bonds. You can instinctively tell that, by imagining how much interest you’d lose if rates rose by 1% the day after you opened the account.
A 24-hour delay would have netted you an extra £1 in interest per £100 saved for the next three years. Whipping out our compound interest microscope we can see:
£107.06 would be ours after saving £100 for three years at 2.3% interest per year –versus a paltry £103.95 in an alternative universe where we only earned 1.3% interest.
103.95 / 107.06 x 100 = 97.1%, or a 2.9% loss if you were condemned to life in that wrong universe.
Pop this battle royale into a duration calculator and you get a duration of 2.9 – confirming the 2.9% loss for the 1% rise in interest rate.
If you’re as anal as I am then you can put the very same particulars into a bond pricing calculator. The value of your £100 drops to £97.13 due to the 1% interest rise. High five! (C’mon, don’t leave me hanging…)
The savings ‘bond’ is essentially the same as the outmoded gilt. You’ll take a 3% loss if you stick with it. Except that on the bond market you’ve already taken that capital loss quicker than you can say, ‘Bond Apocalypse’. Whereas all you need do with the cash is foist the unwanted savings account back on to the bank. It’s like financial wardrobing.
If the switch costs you less than 3% (in this case) then that’s another win for cash over similar maturity gilts.
Suppose that busting out of your savings account incurs a penalty of 180 days interest.
180 / 365 x 100 = 49.3% (the percentage of your interest rate that you’ll lose that year).
0.493 x 1.3 (the account’s annual rate of interest) = 0.64% (loss of interest that year).
You’re paying a 0.64% cost to ditch the savings account versus a 3% loss on the gilts.
This calculator shows you the interest rate you’ll actually get on a fixed rate savings account if you take an early withdrawal charge.
And this early withdrawal calculator from the excellent Finance Buff goes a stage further if you can’t decide whether to stay or go.
The comparison between cash and gilt losses only worsens as maturities lengthen. If you’re the Nostradamus of interest rate forecasts then you know what to do…
Where gilts tend to excel – especially over the last two decades – is spiking in price when equities are jumping off a cliff.
Source: JustETF.com
The chart shows gilt ETFs peaking in unison on 9 March 2020. The longer their maturity, the higher they surge:
When global equities hit bottom on March 23, a 60:40 portfolio (blue line) was in much better shape than a 100% equities portfolio (green line):
The 60:40 portfolio was down 16% while equities face-planted -26%. Of course, -16% isn’t great, but you can see the ride is gentler and that can make the difference between panicking and holding on.
The 60:40 intermediate gilt portfolio performed better than its cash cousin but not by much.
At the height of the crisis, this portfolio was down 14%. I was very glad I held gilts on 23 March but I doubt I’d have freaked out at -16% either. With that said, everybody has a tipping point…
Still, this is only one data point. Intermediate gilts did much better during the Global Financial Crisis when they rose 19% while global equities tanked -38%.
You could argue that the spike in gilts gives you more firepower when you rebalance. That’s true, although many studies have shown the rebalancing bonus to be small to non-existent. You also have to actually be able to rebalance into the teeth of the storm.
It’s worth noting that if your cash is in variable rate accounts then yields will most likely tumble during a recession (witness the rate slashing of the last few months). Your gilts can still make capital gains, which may be usefully rebalanced when you regain your poise.
It’s easy to forget in our polarised age that there is an alternative to ‘For’ versus ‘Against’.
Do we have to choose cash or bonds? The very point of diversification is that we place our chips on both.
120 years of UK asset returns shows that you were better off holding some cash in your portfolio 62% of the time when equities scored an annual loss. (Although cash has taken a beating every year since 2008 versus gilts and equities).
History also tells us that cash has been nothing but a drag on sustainable withdrawal rates if you want your retirement portfolio to last longer than 25 years.
I’m not attracted to this time is different theories but we are living through strange times. As yields fall below zero, cash and short-term gilts act like clapped out O-rings and lose their ability to contain losses. But long bonds (a proportion of which are held in intermediate gilt funds) can still make huge countervailing gains in sub-zero conditions.
It’s interest rate risk that looms largest in most people’s minds when they think about bonds, though. I know I didn’t want it holding me back when I first started investing. As a result, the defensive side of my portfolio was all in cash that doubled up as an emergency fund. Not best practice.
Back in those days I ignored two major risks:
Without a plan to ease off the brakes, there’s every chance you could careen off the road during a future pile-up.
To that end, government bonds still provide the best stopping power you can buy.
And I’ll keep making room in my portfolio for gilts and cash because, well, diversification.
Take it steady,
The Accumulator
Bonus appendix: miscellaneous ‘cash vs bonds’ tie-breakers
As everyone in the UK is aware since that incident with Northern Rock, banks can go bust. Up to £85,000 worth of your cash is protected per ‘authorised institution’ thanks to the FSCS compensation scheme.
That sounds pretty sweet until you find out that 100% of your readies are protected when you hand them over to the British Government in exchange for an IOU – aka a gilt. Her Majesty’s Treasury will definitely pay you back.2
That in turn sounds pretty sweet until you check out the investor compensation scheme and realise that your 100% protected gilt holdings could disappear in a puff of mismanagement if your fund or platform provider went down in mysterious circumstances.
Then you’re back to £85,000 compensation, or less if the FSCS scheme turns out not to apply. A disaster like this is not likely but it could happen and it casts new shade on the whole ‘backstopped by the UK’ promise.
The sweet spot is cash parked in the National Savings & Investments (NS&I) bank. NS&I savings are guaranteed by the government and there’s no other weak link in the chain forcing me to write several lines of warning.
Better still, NS&I savings products are hot right now especially as the government has a huge hole to plug in the public finances.
Even better than that, you can pop eligible NS&I products into your SIPP. Although it looks like only owners of expensive ‘full’ SIPPs and SSAS vehicles need apply. ‘Simple’ SIPPs – as offered by most platforms – don’t look like they co-operate.
But I’m not expecting NS&I index-linked certificates to come back any time soon. These amazing inflation shields – perfectly tailored for the little guy – are subject to a value-for-money test by the Treasury. That pits them against the cost to the public purse of raising funds in the wholesale markets using equivalent gilts.
As the government has been able to issue index-linked3 gilts at negative real yields for several years, I don’t think they’re likely to come to the likes of you and me for a few billion, even if we agreed to an interest rate of CPI +0%.
Cash in a savings account doesn’t incur dealing fees or OCF charges but that’s neither here nor there when you’re making strategic asset allocation decisions. Most passive investors can hold gilt index trackers extremely cheaply.
Individual gilts are not liable to capital gains whereas gilt funds are.
Interest paid by bonds and bond funds benefits from your tax-exempt Personal Savings Allowance and Starting Rate for Savings, just as cash does.
What caught my eye this week.
I have mentioned before my group of friends on an email list who’ve been debating Covid-19 since January.
Well, this same group of friends was previously preoccupied by arguing the future of cash.
I think cash use is doomed to dwindle in the West, probably fast. Most of them think that would be terrible.
Now it seems the streams are crossing. It’s becoming clear from the data that cash use has crashed in the Covid-19 era and the knock-on lockdown.
I have shares in a bunch of listed and unlisted fintechs and payment companies that have seen their prospects skyrocket since physically touching anything except a bar of soap became oh so 2019.
Some are seeing higher volumes, such as the automated savings app Chip.
Others are taking a short-term hit to their ‘take’ because overall spending is down – but they are seeing more users turn to their products, which bodes very well for the future. Square and Visa are examples here.
The trend is their friend. Just this week I received another press release suggesting UK consumers are increasingly shunning cash.
The release – from a technology and branding company called Toluna – states:
Rather like the feasibility of working from home seems to have astonished half of UK PLC, the infrastructure for the cashless society was already pretty much in place before many people decided to finally try it.
I agree with my friends that some marginalized – particularly elderly – communities may not be super-comfortable using the latest fintech app to monitor their finances, or to wave their mobile phone to buy a pint of milk.
But where I disagree is the claim that this is an insurmountable problem.
A determined effort by the government and the private sector could create some kind of universal digital option for those still living pre-2005.
Just a State-issued contactless card and monthly paper statements in the post would do in a pinch.
But of course I’d rather everyone got more ambitious. Because where I really disagree with my friends is when they claim that ditching cash is disempowering from a budgeting perspective.
The power of apps like Money Dashboard1 leaves counting out coins from a jam jar in the dust.
Indeed even the most humdrum mobile bank accounts are beginning to boast features that were the cutting-edge from whizzy start-ups in East London just a few years ago.
I do agree with my chums in three respects, however.
Firstly, the cashless digital society is in need of a back-up plan when, metaphorically, the battery runs out.
This could be because I forgot to charge my phone or because a financial service provider is hacked, crashed, or forgot to charge its phones (/servers).
I can think of various ways around this – solutions using biometrics, cryptocurrencies, and short-term (invisible?) peer-to-peer lending.
But until they exist, the case for keeping a wodge of tenners as an option is strong.
Secondly, digital payments are far more friction-free. And it’s true this could encourage more thoughtless spending. However that’s nothing new. We’ve had credit cards for decades. As I say, at least with digital payments you have the potential to build in all kinds of automated checks and balances that you can’t do with dumb cash.
Finally, to lose the cash option is definitely to lose some privacy.
Perhaps that will be the edge case that finally leads to a Bitcoin usage explosion? Not for buying illicit drugs on an Internet backwater, but for paying for more humdrum items that you’d still rather a spouse or the government didn’t see.
I’ve come around to the view that Covid-19 is going to change more than seemed likely six months ago.
Encouraging the demise of cash is near the top of that list, I reckon.
What caught my eye this week.
The US may be about to see another surge in Covid-19 deaths. This is clearly tragic from a human perspective. We might also wonder what it will do to the market.
I’ve been pretty relaxed about the UK’s de-lockdown. Daily cases have steadily fallen, contrary to – soon forgotten – warnings at every stage that we were moving too fast.
Indeed it was probably only around 4 July that we went much past where I’d have set the limits for the actual lockdown! Albeit partly with the benefit of hindsight.
My hunch is 90% of the heavy lifting of preventing a rapid escalation of Covid-19, at least in summer, comes from basic social distancing and hygiene, and perhaps wearing masks inside.
Throw in today’s testing capacity – spectacularly absent back when many of us thought we had the virus – and it looks to me like enough to at least keep the situation contained.
Shutting down the economy, paying extra billions in furlough, not leaving the house more than once a day, keeping lovers apart for three months – I doubt it made much more difference. We should have focused instead on ring-of-steeling care homes. From day one it was the elderly who were clearly most at risk.
Still, reasonable people can disagree.
Early, when total cases are very low, maybe extermination from a heavy lockdown is an appropriate goal. Maybe if you’re going to get a 15% hit to GDP you might as well take a 20% hit and try to wallop the thing on the head. Fresh flare-ups in Australia and Hong Kong reinforce my doubts on that score, but even experts debate this – and I’m far from that!
But I still believe the case for uber-lockdown ignores myriad unforeseen costs and consequences.
Something I learned from Tim Harford this week is called the identifiable victim effect.
For example, after the Fukushima nuclear disaster in Japan, hundreds of thousands of people were made to relocate from their homes for years on end.
Obviously, right? Nobody wants citizens getting sick from radiation.
Right, except it’s now thought relatively few lives were saved by the relocation. In fact it’s possible more evacuees killed themselves from the emotional wrench of separation and upheaval than would have died from radioactive fallout.
At least 50 suicides have been recorded. And there will have been tens of thousands of smaller tragedies, from job losses and broken relationships to farms falling into disrepair.
It’s all incredibly sad – but try making that argument when the Geiger counters are going haywire. I’m sure I’d have relocated them, too. Most politicians wouldn’t hesitate.
Some more emotive arguments about Covid-19, especially in the early days, saw this identifiable victim effect loom large.
Still, I know that one thing all1 readers of this website will agree on is that Covid-19 is not a hoax…
…that being asked to wear a mask isn’t a plot to turn us into communists.
…and that saying a less full-on lockdown might have been more proportionate doesn’t mean I’m saying we should do nothing, or pretend the virus isn’t happening.
Yet, incredibly, swathes of Americans appear to have reached exactly those conclusions. A lunatic fringe apparently even believes ex-President Obama created the virus and is spreading it.
(So this is how democracy dies. Not with a bang but a “WTF? Really?”)
You can understand why the saner end of this happened. The US is a huge country. Much of the US was in lockdown when it probably didn’t need to be. Local lockdowns and exclusion zones might have been more pragmatic, and caused less frustration. Although this is with hindsight – I imagine the US health officials didn’t expect things would eventually go so far off the deep end.
Anyway, the end result is the virus seems to be taking off rampantly again.
I have tried to stay open-minded about this. In particular the US is now doing over 600,000 Covid-19 tests a day. It’s a truism (not a Trumpism) that if you increase testing in a pandemic you’ll find more carriers. So it was plausible that part of the surge in US cases was down to the huge ramp in testing.
(Imagine if we’d been able to test everyone in London over a few days in early April. We might have found half a million people with the virus!)
As you test more people though, what you don’t want to see is the percentage of positive results going up. That means you’re not just finding more Covid-19 carriers through more tests – it also implies there’s a growing number of them out there.
And what you really don’t want to see is daily deaths go up.
Unfortunately the US is now seeing dramatically more positive test results:
(Click to enlarge the misery)
This might not have been definitely terrible. I suspect young people have had enough of putting their lives on hold for something that will only badly affect a tiny minority. When respected US medical figures say as much as 50% of the US population will probably have had Covid-19 by the end of the year, you might well ask why not get it over with? Sure enough, the average age associated with a positive result has been getting younger in the US.
However, the counter-argument to the ‘let rip’ thesis is that eventually the pandemic ebbs up to and kills a swathe of the vulnerable.
And in my daily chart checks, that’s what I’ve noticed may now be happening:
(Click to enlarge: Notice uptick at far right-hand side)
Two questions for the market.
Firstly, is this uptick just an artifact of the natural history of the virus?
I’ve noted before it’s still not clear why thousands die in some places and other places get off fairly lightly. Maybe Covid-19 has taken a while to get embedded in some larger and more clement US environs? This is grim news for people living in such places. But it could mean a nationwide resurgence isn’t inevitable.
Secondly, is the US effectively going for a Swedish approach? Not openly stated, but de facto.
Again, this always seemed a plausible endgame to me with a virus this transmissible, and yet apparently ultimately harmless to most. The cost of repeated shutdowns is just too great.
It’s worth noting that for all the wailing and gnashing of teeth, the Swedish approach has sort of worked.
Yes, before *you* say it, plenty of people have died. As I always reply, we’ll only see in the end how premature much of this death really was.
But more importantly for this discussion, many were arguing in April and May that only stringent lockdown could curb the spread of the virus.
The Swedish experience, painful as it was, seems to show that’s not true:
(Click to enlarge the counterfactual)
Through one lens Sweden’s approach looks like a failure. It comes fifth ranked on deaths per capita from Covid-19. (Though that’s still better than lockdown-happy Britain at third).
But this isn’t the argument I’m making here. I’m simply saying a looser policy that accepts the virus will spread and run its course isn’t a catastrophic policy from the set of bad choices on offer.
The US may be about to find out, one way or another. Frustratingly, I could see the market taking this news either way.
Bluntly and economically-speaking, it probably fears another fully-loaded economic shutdown more than a higher death tempo among the elderly.
On the other hand, a return to New York-like scenes on the news is hard to square with a recovering economy let alone buoyant share prices – even if the very worst fears and tail risks of this pandemic have now been lopped off the distribution graph.
Hold on to your hats (/allocation to bonds and cash). Things could be about to get bumpy.
