Investing cash when market is at record highs

Author: Alex Funk, CIO & Tara Jameson, Multi-Asset Fund Manager at Schroders

The belief that interest rates will fall this year has made assets such as cash and bonds less attractive to investors and driven some stock markets to record highs. But the latest data released by the US Bureau of Labor has shown that all is not so well in the economy and has caused investors to panic.

In the US, January's consumer price index rose more than expected as high housing prices weighed on consumers, increasing by 3.1%. This data has shaken stock markets amid bets that the Fed would start cutting rates in May.

But the truth is that, despite these poor results, at Schroders we believe that after peaking at around 9% in the second half of 2022, disinflationary trends are clear and central banks no longer need to keep interest rates so high.

The belief that inflation has been brought under control has caused some markets to trade near all-time highs. And this raises a difficult question for many investors who moved to invest more in cash in 2023, attracted by the high rates on offer: if central banks start cutting rates, should they be afraid to invest that cash when markets are at record highs?

The US stock market reached its all-time high in mid-December 2023 and has continued to rise ever since. At the end of January, it was almost 3% above the previous high, which has made many investors nervous about the possibility of a fall.

The importance of investor psychology

In reality, the market makes all-time highs more often than you might think. According to a study by Schroders, of the 1176 months since January 1926, the market made record highs in 354 of them. If you really look at the data and how many times the S&P has been at an all-time high, it has happened 30% of the time. And actually the investment results have not been bad if the purchase was made during an all time high. If we look back, we would have beaten inflation by 10.3% investing at all-time highs, compared to 8.6% in other periods. So investing at market peaks is not necessarily a bad thing.

Over long time horizons, differences in returns can accumulate and gain weight. If $100 had been invested in the US stock market in 1926 and remained unchanged, it would now be worth about $85,000, according to Schroders data.

By contrast, a strategy that exited the market and entered cash over the next month every time the market hit an all-time high (and re-entered when the market was not at a high) would be worth only $8,790, 90% less. In conclusion, it is normal to be nervous about the future when the stock market is at record highs, but giving in to that sentiment would have been very detrimental to investments.

The battle to beat inflation is not yet won.

Although there are signs that we are getting closer to the 2% target set by the European Central Bank, the reality is that we are going to see more volatility in the future. This is evident in our 3D Reset analysis, which describes three major structural forces that we believe will shape the investment landscape in the coming years and create more inflationary pressure in the future: demographics, de-globalisation and decarbonisation.

Ageing populations create labour shortages, driving up wages. Offshoring or redirecting supply chains to provide security is costly. And cleaning up our energy supply and consumption is expensive in the short term.