King Cash Is Being Dethroned. What to Buy Now.

Wall Street is eagerly anticipating a flood of cash coming into equity and fixed-income markets. “I wake up every morning salivating about the $7 trillion that’s sitting in money-market accounts that’s waiting to move,” says Rob Kapito, president of BlackRock, which oversees more than $3.5 trillion in iShares exchange-traded funds.

Even if money-fund yields don’t fall much, holding cash for too long can have steep opportunity costs. Investors who sat out the stock market’s rally last year missed out on the
S&P 500’s
26% return. Bonds also edged out cash, returning an average 5.5%, based on the Bloomberg U.S. Aggregate Bond Index.

“Last year is a textbook example as to why trying to sit out in cash and time the market is generally a bad move,” says John Boyd, founder of MDRN Wealth.  

Inflation and taxes may also erode returns. A money-market fund’s 5% headline yield whittles down to a “real yield” of 1.6%, based on the latest consumer price index at 3.4%. If you hold money-market funds in a taxable account, your take-home yield could be lower.

“Cash is like the frog in tepid water that is being brought to a boil,” says Blair duQuesnay, a senior investment advisor at Ritholtz Wealth Management. “There’s a huge opportunity cost to not investing in markets and just sitting in cash, which you’re expecting to lose value to inflation,” she adds.

Bonds Could Beat Cash This Year

With interest rates potentially heading down this year, the outlook for bonds looks healthier. While bonds have already rallied, Jeffrey Johnson, head of fixed-income product at Vanguard, sees value in the market and says it’s important not to dillydally. “One of the keys here is for investors to not wait too long,” he says. “It’s really important in this environment to be looking forward, not behind.”

Investors might consider a three-pronged strategy, going from safest to riskiest: short term, intermediate/core, and more speculative “junk.”

Short-term yields closely track expectations for the Fed’s interest-rate moves. Several Vanguard ETFs track the market at ultralow cost, including the
Vanguard Short-Term Bond
ETF and
Vanguard Short-Term Corporate Bond
ETF. Both have expense ratios of just 0.04% and yield around 4.5%.

Actively managed bond ETFs may yield a bit more. The
Pimco Enhanced Short Maturity Active
ETF uses securitized debt, futures, and options to generate a 5.4% yield. Others to consider include the
JPMorgan Ultra-Short Income
ETF, yielding 5.4%, and
BlackRock Ultra Short-Term Bond,
with a 5.5% payout.

Intermediate-term bonds may not yield as much due to the inversion of the yield curve, pushing short-term yields above those on the long end. But in a falling-rate climate, investors could pick up higher total returns—a mix of capital gains and income—in longer-term securities that are more rate sensitive. “That’s a pretty safe way of getting exposure to the bond market,” duQuesnay says.

The
Vanguard Total Bond Market
ETF covers the belly of the market, with a fee of just 0.03% and a yield of 4.3%. It’s up 6.1% over the past three months, trouncing Vanguard’s short-term bond ETFs.

Bonds can also provide some ballast against equity declines. That didn’t happen as the Fed hiked rates, pressuring both stocks and bonds, but now that rate hikes are likely over, high-quality intermediate term bonds should get back to their role as a hedge against equity downturns, says Jeff Klingelhofer, co-head of investments at Thornburg Investment Management. “If the world does move into a recessionary environment,” he says, “high-quality fixed-income portfolios should be negatively correlated with other asset classes—they should go up.”

A mutual fund he co-manages,
Thornburg Strategic Income,
yields 4.15% and has a solid record, beating 83% of peers over the past 15 years on an annualized basis.

On the riskier side of the spectrum are junk bonds and alternative credit.

Michael Contopoulos, director of fixed income at Richard Bernstein Advisors, likes collateralized loan obligations, or CLOs, with AAA credit ratings. These are securitized products with cash flows from an underlying collateral pool distributed by priority, he says. The AAA-rated CLOs get first dibs on income from the pool, granting them the high credit rating. The debt is floating rate, pegged to a short-term market benchmark, and now yields around 7%, he points out.

The
Janus Henderson AAA CLO
ETF, with $6 billion in assets, offers a 6.8% SEC yield.
VanEck CLO,
with $240.6 million, yields 6.7%.

In junk bonds, it may pay to stick with an active manager that can avoid securities with high default risk.
Osterweis Strategic Income
emphasizes short-term bonds from issuers with ”ample cash and equivalents.” The fund yields 5.68%, below the junk average of 7.4%, and its 15-year returns trail the category average. But recent performance has been solid, landing the fund ahead of 95% of peers over the past three years.

Swapping Some Cash for Stocks

With the markets near record highs, it may be tempting to stay on the sidelines and wait for a pullback. Investing at regular intervals, say on the 15th of every month, can mitigate some risk of buying at a peak.

One bullish signal to watch is the two-year Treasury yield. Declines in that yield have coincided with cash coming out of money-market funds and stock market rallies, according to DataTrek co-founder Nicholas Colas. As two-year yields decline, “capital leaves the money-market fund ‘parking lot’ and ventures out to find riskier assets with hopefully better returns,” he wrote in a recent note.

Several strategists see the S&P 500 having a banner year. Edward Yardeni, president of Yardeni Research, sees the index hitting 5,400 by year end, up around 10% from recent levels. John Lynch, chief investment officer for Comerica Wealth Management, has a 5,200 year-end target.

The S&P 500, of course, is heavily weighted to Big Tech, posing risks if megacap tech stocks falter. Lynch favors a more balanced approach. “At this point in the cycle, I’m really not going to swing for the fences,” he says. “I’d like to keep it as close as possible between growth and value.”

One sector he’s upbeat about is healthcare, where he expects earnings growth of 17% to18% this year. The sector had an abysmal 2023 but is edging the market early this year. Lynch likes its defensive properties, including solid dividends and earnings growth. The
Health Care Select Sector SPDR
ETF offers broad exposure to the industry, holding giants like
Eli Lilly,

UnitedHealth Group,
and
Johnson & Johnson.

Also in the defensive camp is Thornburg’s Klingelhofer. “Surround yourself with strong, moat-type companies that will have the wherewithal through thick and thin, whether we get a recession or not,” he says. Stocks he likes include financials such as
JPMorgan Chase
and
Charles Schwab.

Another strategy is simply to “follow the profits,” says Michael Rosen, chief investment officer at Angeles Investments. His firm emphasizes growth over value, large-caps over small-caps, and U.S. over foreign stocks. “Those characteristics are where the profits are,” he says. 

One mutual fund to consider is
Primecap Odyssey Aggressive Growth,
which reopened to new investors in December 2022. It has underperformed in recent years but has a stellar long-term record, with average annual total returns of 16.33% over 15 years, beating 97% of its peers in the mid-cap growth category, according to Morningstar. 

Daniel Wiener, founder of RWA Wealth Partners, likes the fund’s focus on “growth at a reasonable price.” The managers look for catalysts that can get a stock moving, he says, and he likes their emphasis on biotech and tech. “My single largest personal holdings are in funds run by these guys,” he says.

One big beneficiary of cash could also be dividend-income strategies. Savita Subramanian, head of U.S. equity and quantitative strategy at BofA Securities, likes dividend stocks in the second quintile of yield. Those companies tend to have ample cash flows to support dividend increases, and they pose less risk of cuts than stocks with the highest yields, she says.

One ETF that follows this strategy is
Vanguard High Dividend Yield.
It holds big, sturdy companies like JPMorgan,
Broadcom,

Exxon Mobil,
and
Home Depot,
and it yields 3%. Over the past 15 years, the ETF has returned 12.75%, putting it in the top 24% of peers.

Sticking with quality dividends, Subramanian says, “is the best-kept secret in investing.”

Write to Lauren Foster at [email protected]