Why Wells Fargo says investors have key decisions to make amid Fed easing cycle By Investing.com

Investing.com – It may be time for investors to make key decisions about their alternative cash allocations and fixed income positions as the Federal Reserve begins a policy easing drive, according to analysts at Wells Fargo.

In a note to clients, analysts said carrying cash provides investors with a steady stream of interest while avoiding volatility in the bond market since the Fed began raising interest rates to their highest levels in more than two decades in 2022. Cash investments may come with lower levels of risk. , albeit usually with lower returns.

However, they point out two risks about continuing with a cash-focused strategy in the current trading environment.

First, analysts said, those with a large cash position face reinvestment risk, or the potential loss of the opportunity to reinvest future cash flows at the current rate of return.

The second risk, they said, revolves around money market funds becoming a “cash constraint” over a longer period of time. The term refers to holding a portion of a portfolio in cash rather than investing it in the market.

“Over time, riskier assets have outperformed cash and alternative monetary instruments,” they wrote. “Our study of long-term capital market assumptions shows that US stocks outperformed cash returns (…). The strength of compound returns has generally benefited riskier assets such as stocks while leaving cash at a disadvantage (…).”

As a result, they caution investors to avoid using cash as a long-term investment strategy or large allocation.

Instead, they recommended allocating cash across asset classes, adding that this focus on diversification offers “a combination of growth potential and risk management conditions” especially for “investors with a strategic time horizon.”

Analysts believe that in light of the uncertainty surrounding the Federal Reserve’s policy plans and the results of the US presidential elections, investment portfolios should focus on quality – especially large-cap companies at the expense of small and medium-sized companies.

At the same time, recent volatility in stock markets would push investors into sectors such as telecommunications services, energy, financials, industrials and materials and trim positions in areas such as consumer discretionary, consumer staples, real estate and utilities, they added.

Elsewhere, bond investors should expect short-term investments to decline in conjunction with expected additional interest rate cuts by the Fed before the end of 2024. The central bank already moved to cut borrowing costs by 50 basis points last week.

“The relatively high returns that investors have enjoyed over the past two years in high-quality, short-term investments will decline,” Wells Fargo analysts said.

“On the other hand, moving to longer-term maturities to secure higher yields exposes investors to the possibility of significant market price movements and potential losses if the economy accelerates and longer-term yields rise next year.”