Cash Is Raising the Bar for Stocks

You now can earn an annualized yield of 5.23% on a six-month U.S. Treasury bill, the most that particular security has paid in more than five years.

Can’t get too excited about 5.23%? True, it’s barely halfway to a double-digit return. But as Einstein noted, everything’s relative.

The T-bill rate is more than twice the mere 2.5% a year that the blue-chip Standard & Poor’s 500 stock index has earned over the last five years, including dividends.

A 5.23% return, compounded, would double your money in 13.6 years.

And if you’re worried about beating inflation, a 5.23% yield is 1 full percentage point above the 4.2% jump in the consumer price index over the last 12 months. (And that’s the real consumer price index, not that “core” CPI that excludes food and energy costs.)

Plenty of nasty things have been said about the Federal Reserve’s credit-tightening campaign of the last two years. But there is a positive: The Fed has lifted short-term interest rates to levels that make saving money in so-called cash accounts worthwhile again.

With the central bank’s latest move -- the quarter-point increase in its benchmark rate to 5.25% on Thursday -- the Fed probably has assured that Treasury bill yields won’t be going much lower anytime soon, and may yet go higher.

Interest rates on other cash accounts, such as money market mutual funds and bank saving certificates, are likely to continue rising as well. Which may give some people pause about putting money into stocks, bonds or other risky assets, if they have funds to invest. In a cash account, the risk of loss is virtually zero.

“Cash is increasingly becoming a legitimate asset class,” says Jack Ablin, chief investment officer at Harris Private Bank in Chicago.

By legitimate, of course, he means that cash accounts offer genuine competition for what Wall Street considers to be true investments.

But is that a foolish notion? Anyone who knows the basic rules of investing can recite the standard line about cash: In the long run, it’s going to pay you a lot less than stocks or bonds. Cash accounts are fine for your emergency funds, but not for true investment dollars.

Historical market performance data would seem to bear that out. From 1926 through 2005, U.S. blue-chip stocks produced an average total return of 10.4% a year, according to data tracker Ibbotson Associates.

Long-term government bonds generated an average total return of 5.5% a year in that period.

Treasury bills, by contrast, earned 3.7% a year in that period, on average.

Yet there have been extended periods within that 80-year time frame when cash beat both stocks and bonds.

From 1966 through 1979, for example, T-bills earned 6% a year, on average. That topped the 5.1% average annual return on blue-chip stocks in that period, and the 3.1% average annual return on long-term government bonds.

Stock market bulls will scream “Unfair!” at using data from ’66 to ’79. That was a terrible time for investing, as inflation surged to double-digit levels.

Inflation is a problem once again, if you believe the Fed. But no one is suggesting it’s going to be a double-digit problem.

Even if Fed policymakers were to hold short-term rates around current levels for the next few years -- as they did from mid-1995 through mid-1998 -- shouldn’t stocks be able to beat a 5.23% average annual return?

The S&P; 500, as noted above, has gained less than half that amount over the last five years. But many other stock sectors have done far better. The average foreign-stock mutual fund has risen 11% a year in that period, according to Lipper Inc. The average small-stock mutual fund has gained about 9% a year.

What’s more, it’s precisely because U.S. blue-chip stocks have done so poorly over the last five years that their fans say the next five years are bound to be better. Every dog has its day.

But you won’t persuade Bob Shiller. In spring of 2000, the Yale University economics professor published his book “Irrational Exuberance,” the central theme of which was that stocks were grossly overpriced. In the book, Shiller forecast that the S&P; 500 index would post no net gain over the following 10 years.

More than halfway through the decade, he’s on target: The S&P; index still is 17% below its all-time high set in March 2000.

How now, Bob? Reached at Yale last week, the 60-year-old Shiller said he saw no reason to back off from his 2000 forecast. His own money, he said, is largely in Treasury bills.

Even though blue-chip share prices are much lower than they were in 2000, relative to underlying earnings, Shiller said he thought they could go lower still. He says he’s particularly concerned about the weakening housing market and the effect that might have on Americans’ ability and willingness to spend money, and therefore the effect on the economy. And stocks, after all, are bets on the economy.

He sees this as “a period of gradual disenchantment with equities” that could go on for years.

That view, however, plays right into the hands of market bulls, as do other arguments for favoring cash now. Cash is where investors go when they’re afraid. And it’s often when you’re afraid that the investment opportunities are the most lucrative.

Steve Gorman, head of Gorman Financial Management in Hingham, Mass., advises retirees and pre-retirees on their finances. He says he is sticking with his standard advice for those clients: Maintain a well-diversified portfolio that keeps cash at a minimum, other than emergency funds and money that people know they’ll need to spend in the next few years.

“Most of my clients are targeting a rate of return higher than 5% on their long-term assets,” Gorman said. So T-bills, he said, won’t cut it. And because 60-year-old retirees might live 30 more years, Gorman said, they should feel confident betting that long-term returns on stocks and bonds will beat cash, as they have historically.

As with so many elements of personal finance, the cash debate -- how much is enough to hold, how much is too much -- will depend on the investor and how much risk he or she can tolerate.

At a minimum, what cash-account returns at current levels do is raise the bar for stocks, bonds and other competitors. If the risk-free return is 5.23%, you have to be confident that riskier assets will perform significantly better over time.

Otherwise, there’s no point in bothering with them.

*

Tom Petruno can be reached at tom.petruno@latimes.com. For recent columns on the Web, visit latimes.com/petruno.