Investors poured $136.4 billion into cash in the week through Dec. 4, 2024, the biggest weekly inflow since March 2023, when markets were rattled by a regional banking crisis, according to a report from Bank of America on Friday, per Reuters.
Why Cash Is King
The road ahead in the stock market is a bit unclear. President-elect Trump is likely to instigate a tariff war and push inflation in 2025. If he keeps his campaign promises, America could face an inflation shock even more severely than the one experienced in 2021, per some strategists.
If inflation flares up again, the Fed is less likely to cut rates faster next year. The Fed’s current level of key rates is fixed at 450-475 bps. There is currently a 28% chance of a 100-bp decline in rates by the end of 2025 and a 27% likelihood of rates being cut by 75 bps to 375-400 bps.
Then, there is a slight overvaluation concern. Over the past century, the average P/E (price/earnings) ratio for the S&P 500 has hovered around 15 to 20. The S&P 500’s current P/E stands at 30.67X. Its notable peaks include a P/E ratio exceeding 120 during the 2008-2009 financial crisis and elevated levels of 39.9 at the end of 2020 during the COVID-19 pandemic recovery.
Volatility may become the name of the game thanks to a host of factors ranging from sticky inflation in the United States and other parts of the developed world, uncertainty regarding Trump’s potential policies, fears of a slowdown in China and the resultant pressure on supply chain and global growth, and geopolitical issues.
Due to these uncertainties, investors are probably aiming to reduce their exposure to potential stock market downturns, which is why money-market ETFs may gain. Investors should note that such ultra-short-term bond ETFs have lower interest rate risks. Hence, we believe cash and short-dated fixed income may play a greater role in adding stability to a portfolio.
High Yield Along With Lower Interest Rate Risks: Winning Proposition
As of Dec 5. 2024, the yield on the three-year U.S. treasury note was 4.10%, slightly lower than the 10-year note (i.e., 4.17%). One-year note yielded 4.23%, while one-month note yielded 4.59%. This means that the shorter-duration money market instruments are yielding more.
This puts focus on the ultra-short-term corner of the bond market. Exchange-traded funds (ETFs) like Enhanced Short-Maturity Strategy ETF MINT, Short Maturity Bond iShares ETF NEAR, Ultrashort Term iShares ETF ICSH and iShares 0-3 Month Treasury Bond ETF SGOV are lined up for gains.
Notably, the fund MINT yields 5.28%, NEAR yields 5.03%, ICSH yields 5.26% and SGOV yields 5.18% annually. This means that these funds offer a pretty high current income.
The ETF ICSH has a low effective duration of 0.43 years, while the ETF NEAR has an effective duration of 0.34 years. The ETF MINT has an effective duration of 0.01 years and SGOV has an effective duration of 0.09 years. Such short durations alleviate the interest rate risks associated with bond investing.
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PIMCO Enhanced Short Maturity Active ETF (MINT): ETF Research Reports
iShares Short Duration Bond Active ETF (NEAR): ETF Research Reports
iShares 0-3 Month Treasury Bond ETF (SGOV): ETF Research Reports
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