Viktor Fischer for Forbes: Cash is trash

October 21, 2020

Forbes Magazine put a daring declaration on the cover of its October edition: “Cash is King”. That surprised me, and so I decided to have a look if that’s true, and what the hard data says. That’s because I remember what they taught us in school – the value of money declines with time.

From a long-term perspective, holding cash hasn’t paid off during the past 90 years. Money’s real value was increased a bit by 20-year government bonds and gold, in the short term it was maintained by 30-day government bonds and, it achieved its greatest value thanks to stocks, but overall its value declined significantly between 1925 and 2015 compared to other assets.

Let’s put this in practical terms. In 2019 inflation was 2.8 %, this year the Czech National Bank expects it to be 3.4 %. This means that if in January you had CZK 100,000 in your account, at the end of the year it will be worth CZK 96,712.

The CNB has long been striving to hold inflation at two percent, but current predictions tend to place it at 2.4 % for next year and two percentage points less for 2022. Simple arithmetic tells us that our aforementioned sum of money will continue to lose value, and in three years you will lose more than CZK 7500.

This relatively high rate of inflation is also supported by the CNB’s anti-crisis measures, which reduced the interest rate on the interbank market to 0.25 %, and so we can expect that in the near future will not increase. The US Federal Reserve has already announced that it will maintain these low rates of interest for at least the next three years. Goldman Sachs expects it to maintain it for another two years more.

A comparison of the koruna with other currencies doesn’t come out too well for the Czech currency either. Since the start of the year the Czech koruna fell against the euro by 6.73 % and against the US dollar by 1.67 %. Holding our domestic currency during a crisis therefore doesn’t pay off very much – in short, it loses value. A weak koruna also means more expensive foreign goods, which once again leads to higher inflation. I myself don’t expect the CNB to intervene against the devaluation of the koruna. This is because a weak Czech currency makes Czech products cheaper abroad and increases exports and the inflow of international capital. This simply makes sense in the case of the Czech economy, which is export-oriented.

So, which currency should one invest in? The long-term assumption is the US dollar will continue to decline, primarily due to the huge amount of US debt and its trade deficit. In a time of low interest rates and other monetary stimuli (the ECB’s pandemic emergency purchase programme) what will happen to the euro is also not in a completely clear. Historically, however, economic crises and related increased market volatility have always caused the currencies of developing economies to weaken and grow significantly more volatile – and during times of crisis, the currencies of Central and Eastern Europe are still among these. We’ll certainly have to wait some for the Czech koruna to grow stronger. So what should we do with it, then?

Bank accounts, term deposits, savings accounts

Czechs love cash. Out of roughly CZK 4 billion total household savings, 55 % is in non-term deposit and term deposit accounts. This translates to CZK 200,000 per capita. The problem is that term deposits and savings accounts currently offer interest of about 0.3 % (before tax). So even though with a reasonable 0.3 % interest rate will not cover inflation.

Government bonds

Some countries are offering negative interest on their government birds. For example Germany -0.7 %, Switzerland -0.5 %. Investors in those countries therefore have to pay their governments for lending them their money. Ten-year US Treasury bills have a current yield of about 0.7 % per year (US inflation is predicted to be 1.5 %).

Anti-inflation government bonds – for example the US TIPS – are a category unto themselves. In the Czech Republic anti-inflation bonds have variable yields amounting to the rate of inflation + 0.5 %. Their maturity period is 6 years and the maximum investment amount is CZK 5 million. Aside from anti-inflation bonds, the Czech Republic also issues reinvestment bonds that start at 0.5 % and increase by 0.25 % every year. Unfortunately, these government bonds aren’t very trendy yet: currently bonds valued at CZK 22.8 billion have been issued to only about twenty thousand investors. This represents a little more than 1 % of the cash that Czech households have in their bank accounts.

Corporate bonds

What bonds do Czech investors like more than those from the government? Corporate ones. According to the AKAT association, bond funds manage CZK 153 billion. Historically, their yield has been 2-5 % and often have a 1-4 % front-end load. This means that bond funds carry greater risk than government bonds, but when you include the fees, provide only slightly greater yields.

Bonds can also be used to invest directly in companies, which offer an annual yield of 5-10 %. However, in the Czech Republic they are usually accompanied by greater risk, one not commensurate to their yield. Recall what happened to the bonds of companies like Zoot or EMC. Many companies use this form of privately issued bonds when they are unable to obtain bank financing or should be looking for equity financing.

Direct investment in company bonds is relatively complicated and is recommended only for experienced investors. Direct investments into corporate bonds should not represent more than 3-4 % of a portfolio. what are my personal criteria for investing in companies through bonds? Firstly,
profitability, secondly revenue and margin growth, then loan collateral, a skilled management team I know, and finally a clear indication of how the investment will be used.

Real estate

The fact is, real estate prices are growing. In the third quarter of this year prices in Prague levelled off, but they are still at roughly 101 % of their level in October of the previous year. Apartments are simply still selling at pre-crisis prices.

Price growth is influenced by several factors: availability of cheap financing, the economy, and investor demand for relatively conservative assets with potential for preserving their value over the long term.

Mortgages are growing, and so we’re on the way to a record-breaking year. In August of this year alone, applicants were given CZK 20 billion, which is thirty percent more than in the same month last year.

The previous peak was in 2016, when CZK 225 in mortgages was “handed out”. and it looks like this year will set a new high. It’s quite likely that mortgage rates will continue to decline, because the CNB’s repo rate is at 0.25 % and SWAP is at 0.5 %. Many banks are providing mortgages at rates below 2 % and in October the ČSOB Group and Raiffeisenbank will be lowering their mortgage rates.

The economy and unemployment and GDP trends aren’t as in as rough shape as in other countries. The Czech unemployment rate grew from 2.4 to 3.4 %, which is still a lot lower than the USA’s 8 % or Germany’s 6.4 %.

As far as GDP goes, based on quick economic indicators such as electrical consumption, the number of kilometres travelled by trucks on our highways, or the number passengers at the Prague Airport, we can easily see that Czechs have learned to live with the coronavirus pandemic. The growth in GDP in the third quarter should thus be an optimistic number. The question is, however, what impact the current increase in the number of cases, new measures passed in October by the government, and the expected phasing out of programmes like Antivirus, 24, or Kurzarbeit will have on the economy in the fourth quarter, as well as the impact of any additional government economic stimulus packages in 2021.

Private investors’ fear of long-term inflation and a relative surplus of money in the Czech economy then stimulates demand primarily for apartments as an investment in larger towns and cities.

For the time being, it therefore seems that real estate prices are being propped up not only by the limited supply of apartments, especially in cities, as well as the record number of mortgages, which will be cheaper and cheaper thanks to the central bank’s low interest rates.

Stocks in fog

In the Czech Republic, shares are not among the most popular of topics. Czechs hold about CZK 124 billion in equity funds and CZK 220 billion in mixed funds. Does investing in stocks make sense?
The US S&P500 index is at 3400, which is about 10 % more than its value at the start of the year. It’s as if no recession ever occurred. The growth of the S&P500 is being spurred by tech companies like Facebook, Apple, Google, and Microsoft, which grew by 60 % since the start of the year. The rest of the index grew by only 1 %, and for example the stocks of financial institutions and utility companies declined in value. The fact remains that stocks are high-valuation – their P/E ratio is at 25 and revenues per share are declining.

Goldman Sachs expects stock markets to grow over the long term – an average of 6 % over the next ten years with a possible minimum of 2 % and a maximum of 11 %. From a long-term perspective, stocks should cover inflation. But you need to have nerves of steel. Volatility, measured with the VIX index, achieved record values in March 2020, comparable only with the 2008 financial crisis, and remains high.

The continuing high values of VIX can be compared to driving a car at 200 km/h in fog when you can see only three metres ahead of you.

Blockchain

Blockchain is a technology that allows financial services to be provided outside the traditional banking system. Instead of thousands of “expensive” bank employees, everything is managed by a computers and a software code. The volume of financial products and services using blockchain technology is already relatively large, generating about 15 billion dollars in revenue annually, with total capitalization around 350 billion dollars, and has grown by 70 % since the start of the year. But it is still substantially smaller than the total banking market. And it’s also substantially smaller than the market capitalization of financial products: gold ($7 billion), stocks ($89 billion), bonds ($250 billion), or derivatives ($500 billion).

Now you’re probably expecting me to immediately and without hesitation recommend investing in blockchain products and services. Basically, yes. But hand in hand with great caution. It’s a highly technical affair that dedicated funds attend to every day. Due diligence prior to investing should be performed on the team, product, and software code, game theory, and project economics from micro- and macro-economic perspectives.

This year, the financial world changed completely, launching a new era represented by devaluation of currencies, high inflation of assets, low interest on bonds, and a high degree of uncertainty leading to high volatility Data shows that in this day and age, holding cash leads to loss of assets. The run-of-the mill rational investor should at minimum invest into Czech anti-inflation government bonds. Sophisticated ones should prepare for the fact that their investments will have lower yields and higher risk. The only solution that I see is a high degree of diversification – including investment into alternative assets.

Viktor Fischer