Cash Is King In The Changing Financial Landscape

Over 14 years ago in June 2009, I founded my company, Gorilla Post Production. A few months beforehand I, like thousands of others, lost my job during the financial crisis. My career up to that stage had been going quite well having gained 5 years experience in the TV & Film industry as an audio engineer

While my first love was always music and sound, I was equally as passionate about economics which I had studied as an undergrad before going on to do a masters degree some years later. With a background in economics, going out on my own in 2009 was fascinating, if not terrifying. Financial panics on the scale of the Great Recession in 2008 were extremely rare events. My grandparents were barely ten years old during the Great Depression in 1929 while their children’s generation, my parents - the ‘baby boomers’ - lived most of their working lives in a time of peace and prosperity. Down-cycles occurred every ten years or so but the economic contraction arising from 2008 was the most severe in eight decades. As far as I was concerned, I was in uncharted waters.

As it happened, the day I received the keys to Gorilla’s first premises in 2009 was my 30th birthday. Looking back on it now it’s still hard to believe that a young upstart like myself would be lucky enough to land a 2 storey office mews in Dublin 2 for just €10,000 per annum. Even back then, ten grand a year - or €833 per month - seemed like an unbelievable deal. It's a birthday I'll never forget.

The recession, while brutal, had upsides that encouraged start-ups like me to go out and make a go of it. The price of everything had drastically come down, wages included. Tradesmen were two-a-penny and in almost every sector of the economy there was an abundance of skilled unemployed labour desperate to find work. Different times indeed. 

Professional fees in my industry fell by about 50%. Deflation badly affected my established competitors but for me, a start up with a low cost base, the recession suited me quite nicely. With very few overheads, my margins were tight but sufficient to cover my costs with a little bit of change leftover. While declining sales volumes and price reductions for the bigger companies in my industry threatened their viability, my little business started to grow quietly in the background luring new clients with attractive rates in exchange for good reliable services.

Following the crash, the cost of capital also plummeted. In an attempt to avoid a deflationary spiral, the world’s central banks cut interest rates to 0%. In a highly indebted system, this helped distressed households and businesses deleverage in an orderly fashion. Cheaper lending conditions also encouraged firms to borrow, and for capital-intensive companies like my own, lower interest rates were a big deal. Loose financial conditions persisted for over a decade.

One of the downsides of lower interest rates however, was that holders of cash received no return on their investment. Banks paid no interest on deposits which penalised ordinary savers and businesses. Even if only 2% a year or so later, inflation eroded the real value of money when interest rates were so low. As legendary investor and founder of Bridgewater Associates, Ray Dalio, famously said at the time, “Cash is Trash.”

This bearish sentiment on cash drove speculation in financial markets. As the global economy began to recover, stock markets rallied as investors rushed into equities. Quantitative easing (QE) by central banks drove bond prices higher and suppressed bond yields, distorting the true value of debt. Spreads between government securities and riskier corporate bonds narrowed forcing many fixed income investors to chase returns elsewhere. Equities rose higher again.

Fast forward 15 years and financial conditions have been totally upended. High inflation and rising interest rates are now the big news-stories dominating headlines on a daily basis. Interest rates in the US and Europe are at their highest levels since 2007. Equities are now far less appealing given the yield on short-term US treasuries is north of 5%. Bank rates are finally increasing too as political pressure mounts. Cash and bonds look attractive again. Indeed, with oil prices on the rise again too, the likelihood of interest rates being cut anytime soon is very low. 

Last year as interest rates started rising, the tech-heavy Nasdaq index fell by 35%. Lower yielding bonds got crushed too. Traditional 60/40 portfolios provided little protection amid market volatility since both bonds and equities suffered painful sell-offs. While stocks have recovered most of their losses this year, those gains have primarily been in the “Magnificent 7” of Apple, Amazon, Alphabet, Microsoft, Meta, Nvidia and Tesla. This has given some window dressing to equities in 2023 but valuations still look overpriced. Nvidia’s PE ratio, for instance, is 105. Amazon’s is 103.

Gold bugs looking for a 70’s-style return on gold have been disappointed too. Despite high inflation, gold only returned about 4% in the last 12 months leaving many investors scratching their heads. As the graph below shows however, gold prices rise when the dollar falls and vice versa. The pandemic, followed by the war in Ukraine, pushed the dollar to all-time highs and reaffirmed its status as a safe haven. Gold prices remained  weak as a consequence. In the 1970’s when the inflation rate averaged around 8.8% per annum, gold gained an impressive 35% annual return. But that followed a 33% devaluation of the dollar when President Nixon ended the gold peg. As inflation remains more stubborn today than expected, rising bond yields and a strong dollar are likely to keep a lid on gold prices for the foreseeable.
​
Fig 1. The inverse relationship between gold and the dollar.

Source: (https://www.bullionvault.com/gold-news/gold-prices-042020201)

In the short-term at least, holding cash looks like a better all-round bet as global demand starts to decline. Indeed, should today’s stagflationary environment worsen, it would, in many ways, be a tougher business environment than the one I started out in in 2009. Lower demand in combination with higher wages, higher borrowing costs, higher energy prices and a general shortage of workers is truly unique in modern times. These are just some of the headwinds that firms worldwide could be facing over the next 6 – 12 months. Companies with healthy cash reserves will ride the storm better than those relying on expensive bank credit which has soared over the last year. How the world can change on a dime. Cash is king once again.