History suggests that even during abnormal uncertainty, cash has rarely been the best option for multi-asset investors.
Introduction
Amid elevated policy uncertainty and market volatility, some investors might conclude that hiding in cash is a sensible strategy for the next 12 to 18 months. After all, deposit rates across Western markets are still higher than in the 2010s and the macroeconomic picture remains murky, as markets wait to see how tariffs affect global growth and inflation.
However, in our view cash will not prove the best option for investors. Whether the global economy continues to expand or falls into a downturn, we expect cash to underperform other asset classes. Even in a stagflationary scenario, investors can look elsewhere for meaningful portfolio diversification.
Expansion continues
Our base case for the next 12 to 18 months anticipates a slowing but still growing global economy, as tariffs weigh somewhat on consumer demand but household and corporate health keeps activity and labour markets fairly resilient. In this scenario, most Western central banks would be able to gradually reduce policy rates, as the direct inflationary impact of higher trade restrictions is fairly limited and partly offset by somewhat slower growth. Overall, however, policy rates remain higher than the levels of the 2010s. Holding cash might therefore seem attractive.
However, we think equity markets should prove a better investment choice in this state of the world. Ongoing economic growth keeps corporate earnings expanding, even if the pace of expansion slows. This helps currently expensive US stocks grow into their high valuations and supports returns and multiples elsewhere.
Even if investors believe that equity price returns will be muted over the next 12 to 18 months regardless of the growth backdrop – perhaps because there is less scope for multiples to expand from today’s levels, particularly in the US – total returns should still exceed deposit rates. This is thanks to the dividend and buyback income on offer in today’s equity markets, especially in Europe.
Drawdown or downturn
If worsening economic news leads to a stock market drawdown, cash would likely outperform equities as stock valuations contract and analysts pare back their earnings forecasts.
However, we believe core bonds should prove a better choice than cash in this scenario. Today’s still-elevated deposit rates would evaporate as Western central banks cut policy rates in response to lower growth and its impact on medium-term inflation prospects. Thus, cash returns would contract meaningfully. In contrast, the return on core bonds would rise as policy rates fall.
Indeed, at today’s yield levels there is significant scope for fixed income to play its traditional diversifying role in the event of a downturn or recession. If the yield on the US 10-year Treasury fell 200 basis points over one year in response to interest rate cuts by the Federal Reserve, investors could expect a total return of around 20%. In contrast, holding cash would expose investors to significant reinvestment risk.
Stagflation
If the next year starts to resemble 2022, with inflation proving stickier than investors anticipate or even rising, cash investments might seem appealing. Weak growth would likely weigh on equity markets, but sticky inflation could prevent central banks cutting policy rates, holding back core bond returns.
However, investors still have options that could outperform cash. The best solutions would be found in private markets, including real assets such as infrastructure and timber, which were top performers in 2022.
Liquid solutions such as commodity stocks or hedge fund strategies could also prove a better choice in a stagflationary scenario. For example, global macro hedge funds returned nearly 10% over the course of 2022, significantly outperforming cash.
Conclusion
While investors may be aware that cash is never a good long-run option, it can be tempting to hide from elevated uncertainty and market volatility in the short run. Still-elevated deposit rates continue to amplify cash’s temptations.
But in our view, cash is unlikely to outperform a multi-asset portfolio, even over the near term. Whether the global economy expands further, falls into a downturn, or even experiences stagflation, we believe asset classes other than cash will prove better investments. Investors should therefore look to diversify their portfolios broadly, across global equities, fixed income, and inflation-protecting assets – whether these be in private or public markets.
Indeed, history suggests that even during abnormal uncertainty, cash has rarely been the best option for multi-asset investors. After a selection of economic and geopolitical shocks dating back to 1990, a 60/40 portfolio of equities and government bonds has outperformed cash more than 70% of the time over a one-year horizon, and always over three years. The average excess returns above cash are meaningful: 7 percentage points over one year, and more than 20 percentage points over a three-year timeframe. Thus, whatever the outlook for 2025, investors should bear in mind the historical value a diversified multi-asset portfolio has provided and avoid the temptation of cash.