Investors Shifting Cash Out of ‘Park’
A torrent of money may be unleashed soon on the stock and bond markets, as investors finally give up the ghost on short-term interest rates.
Tuesday, stocks soared and bond yields tumbled as the Federal Reserve eased credit another notch to help the feeble economy.
The Fed has been pushing short-term interest rates lower all year. But many investors have failed to react, leaving huge sums of money in bank CDs, money market mutual funds and other short-term parking places--even as those accounts have paid less and less each month.
The events of the past few days suggest that that paralysis may finally be ending and that more investors are willing to switch to potentially higher returns on bonds, stocks and other longer-term investments. “People are realizing that they need to do something,” said Wanda Hershberger, a certified financial planner with Financial Kinetics in Pomona.
The hunger for better returns was dramatically evident on Tuesday:
* A $4.1-billion offering of tax-exempt notes by the state of California received so many bids that the brokerages selling them closed the order window 45 minutes early. “We saw unbelieveable demand,” said Bob Gore, tax-exempt bond chief at brokerage Crowell, Weedon & Co. in Los Angeles.
The flood of purchase orders allowed the brokerages to trim the yield on the notes significantly. Investors were supposed to earn 4.85% on the notes maturing next June; instead, they’ll get 4.75%. Still, if you’re in the combined 37% federal/state income tax bracket, you’d have to earn at least 7.5% on a taxable investment such as a CD to match an untaxed 4.75% return.
* Yields on U.S. Treasury bonds tumbled for a second straight day as money poured into the securities--even in the face of a record $38 billion in new bonds Uncle Sam will sell this week.
Tuesday, the Treasury sold $14.1 billion in new three-year notes at an average yield of 6.92%, down from 7.09% at the last auction on May 7. Meanwhile, the yield on 30-year Treasury bonds dropped to 8.17% from 8.22% Monday. The 30-year yield now is at its lowest level since May, though just slightly below the 8.24% yield at the start of the year.
* The stock market jumped as the prospects of still-lower interest rates fueled optimism about renewed economic growth. The Dow Jones industrial average rocketed 38.24 points, or 1.3%, to 3,027.28--less than nine points from the record high 3,035.33 set on June 3.
The stock and bond markets’ strong gains were sparked by the Federal Reserve’s decision Tuesday to lower the federal funds rate by another quarter-point, to 5.50% from 5.75%. That rate is the cost of money when banks borrow from each other. The Fed can lower the rate by pumping cash into the banking system.
The federal funds rate was 8.25% a year ago. The Fed has been pushing the rate down ever since, cushioning the economy’s slide into recession last winter and greasing the way back onto a growth track in the spring.
As the fed funds rate falls, it pulls down other short-term interest rates such as on money market funds and bank CDs. And that’s what galvanized investors and savers on Tuesday: Already anguished by the paltry 5.5% to 6.5% yields they’ve been taking home on short-term investments this year, many people can’t bear the thought that they’ll soon earn even less .
With the Fed’s latest rate cut, the average seven-day yield on money market mutual funds is likely to fall another 0.10 percentage point over the next four to six weeks, said Martha Wittbrodt, editor of IBC/Donoghue’s Money Fund Report in Holliston, Mass. That would cut the average yield from 5.45% to 5.35%, bringing it near the all-time low of 5.17% set in November, 1986.
Of course, some money fund investors began to move out of those funds and into higher-yielding bond funds months ago. The latest decline in short-term interest rates is likely to persuade many other fund investors to make the move. And not far behind them probably will come a long line of until-now reluctant savers.
Rather than lock into traditional six-month or one-year CDs, many savers have been stashing money in checking accounts or passbook savings accounts this year, waiting in vain for CD yields to turn up. Savings account balances have ballooned from $423 billion to $443 billion just since April 1 as savers have played the waiting game.
But with the Fed’s latest move, CD yields will at best stay flat, and more likely will drop again, many experts say. There’s no use dreaming that the Fed is going to allow short-term interest rates to rise any time soon. “I think we’re going to have slow economic growth and moderating inflation over the next six months,” said Tricia Bannan, manager of the $760-million Phoenix Balanced mutual fund in Hartford, Conn. And that scenario means flat to lower interest rates, she says.
Certainly, that doesn’t mean every savings account dollar will suddenly end up in 30-year Treasury bonds. And in fact, many financial planners are warning investors and savers against panic moves into longer-term securities now. But using reason and logic, you can make the transition to better returns.
Financial Kinetics’ Hershberger recalled how many investors poured their life savings into junk bonds in 1986 and 1987, lured by super-high yields at a time when short-term investments paid relatively little. Many of those junk investments crashed in 1989 and 1990.
For today’s cash-laden clients who are desperate for higher yields, Hershberger first makes sure they’ve got enough liquid funds for emergencies. Then, when they’re ready to invest, “I tell them to pursue quality above all,” she said.
That often means Treasury securities or municipal bonds. And rather than try to predict where interest rates will be a year from now or five years from now, Hershberger constructs a “laddered” portfolio of bonds maturing over a period of years.
For example, if you split your money among 10-year Treasury notes paying 8%, five-year notes paying 7.5% and two-year notes paying 6.6%, you cut the risk involved in trying to pick which of the three is the absolute smartest investment.
(You can construct much the same kind of portfolio using bond mutual funds because there are a host of funds targeting different maturities.)
Do you fear that it’s too late to lock in longer-term yields? Chances are you’re wrong. Long-term interest rates still are historically high. If the limping economy continues to emerge only slowly from recession--as expected--rates could be much lower by 1992.
Besides, holding too much cash almost never pays in the long run. Figure it this way: If stocks and bonds didn’t pay better over time, those markets would have disappeared long ago.
FED TRIES TO EASE INTEREST RATES: A1
Interest Rates Drop Again How key interest rates have fallen since mid-July, anticipating the Federal Reserve’s move to ease credit on Tuesday. In percent Annualized yeild 3-month T-Bill* July 12: 5.57% Tues.: 5.4% 1-year T-Bill* July 12: 5.90% Tues.: 5.56% 5-year T-note July 12: 7.97% Tues.: 7.51% 30-year T-bond July 12: 8.52%Tues.: 8.18%* discount rates Source: Los Angeles Times
Lots of Cash Still Waits Although investors have been pulling out of money market mutual funds in recent months, they have continued to pile huge sums into other short-term “parking places"-such as regular checking accounts and passbook savings accounts. Asset total, in billions Type of account Bank money market accounts April 1: $521.4 Latest: $547.2 Pct. change: +4.9% Savings accounts April 1: $423.1 Latest: $443.2 Pct. change: +4.8% Money mutual funds April 1: $468.1 Latest: $453.6 Pct. change: -3.1% Source: Federal Reserve Bank of St. Louis, Investment Company Institute