Cash Is King, But For How Long More?

Companies are expected to experience increased interest expenses as interest rates rise. However, this doesn't apply universally.

There were companies who took on long-term debts when interest rates were low and currently don't require refinancing. Additionally, some of these companies held substantial cash reserves that benefitted from high interest rates, resulting in the generation of millions of dollars in interest income!

Bloomberg ran a piece on this, highlighting a roster of companies that generated interest income exceeding $200 million during the most recent quarter:

The Big Tech are rather impressive, with Apple and Alphabet earning nearly $1 billion in interest income. High interest rates didn't affect these companies due to their substantial cash holdings and continuous cash generation.

So, who is facing the brunt of this situation? One category includes heavily indebted companies that are currently compelled to refinance their debts amidst higher interest rates. Additionally, companies with limited cash generation capabilities and substantial capital expenditures will find themselves reliant on debts to finance their businesses.

Another set of companies facing potential repercussions are those that operate at a loss and consume cash. These companies can't borrow in the first place because their financial profile won't qualify for loans. However, as the cost of funds increase, their ability to raise funds from investors has dwindled over the past year. Thus, even though these companies don't borrow, they are influenced by the reduced inclination of venture capitalists to invest.

All in all, companies that are cash rich and investing in treasury bills stand to gain. Berkshire Hathaway, for instance, has $147 billion in cash and treasury bills. Assuming an interest rate of 5%, this would translate to approximately $7 billion in interest payments annually!

How long can that last?

The Fed Meeting at Jackson Hole has reviewed that high interest rates are likely to stay longer. The Fed also acknowledged the potential for interest rates to rise further if inflation remains persistent. Projections from futures markets suggest that interest rates are anticipated to remain steady at their present levels until around May 2024, after which a rate cut might occur.

That means that interest rates are likely to remain attractive for another 9 months. Should investors follow these cash-rich companies and park their cash in T-bills too?

I would argue against it. Although receiving a 5% return on risk-free assets is undoubtedly reassuring, such situations are temporary. Let's consider this: if you were to purchase a T-bill now that matures in a year and then witness a 0.5% reduction in interest rates, you might still find it appealing to buy a new T-bill offering a 4.5% interest rate. However, the real question arises if, in the subsequent year, the interest rate plunges to 3%—would you still be inclined to invest in a T-bill?

Moreover, as you contemplate directing your funds towards the stock market, it's probable that stock prices would have already experienced substantial gains. This is exemplified by the current situation: the S&P 500 has surged by 16% year-to-date, translating to a return over 8 months that's akin to three years' worth of 5% annual interest from T-Bills.

Therefore, I don't consider T-bills a viable substitute for long-term investment. Stocks exhibit significantly higher average returns over the long run compared to T-bills. If you have surplus funds and no plans to engage in stock investment, opting for T-bills to generate higher returns on cash does have its merits. However, T-bills should not be viewed as a stand-in for stocks when market conditions appear unsettling. In reality, the reverse holds true: fearful markets offer investors the opportunity to buy stocks at discounted prices.