Despite higher-than-expected U.S. CPI data released last week, there has been a substantial easing in the U.S. annual inflation rate, falling from 9.1% in June 2022 to 3.1% in November 2023.
While bond markets wobbled on the news, Treasuries are still pricing in numerous rate cuts this year. This underscores that the market remains steadfast in the view that a Federal Reserve pivot is coming.
Down under, while inflation has been relatively slow to decrease on the back of RBA interest rate increases, the Consumer Price Index fell more than expected in November 2023. While Australian Government yields are pricing in at least one cut this year, many pundits don’t expect this to eventuate until the final quarter of 2024.
Preparing For A New Monetary Regime
As the certainty of rate cuts become increasing likely, this means that the window of opportunity to secure highly desirable fixed-income returns could be beginning to close.
This isn’t to say that rate cuts are imminent, but now could be an opportune time to consider how portfolios are positioned for a new monetary regime and a potentially weaker economic environment.
With company earnings season in the U.S. now underway and Australian reporting set to commence in February, these results will be an important temperature check for the health of corporate America and Australia.
Crucially, with both the S&P 500 and S&P/ASX 200 sitting marginally below all-time highs, the results will determine whether earnings will be robust enough to justify current valuations.
At the time of writing, the price-to-earnings ratio (PE) of the S&P 500 is approximately 26.41 which is higher than the average PE of 17.87 over the last 10 years.
In the local market, the PE ratio for the S&P/ASX 200 sits at 22, just below the 10-year average of 22.9.
Looking Ahead
With attractive returns of 6-8%p.a. on offer within the corporate fixed-income asset class, investors need to weigh up whether current equity valuations are realistic, especially in the face of a potentially weaker earnings environment.
On the other end of the spectrum, while cash may look attractive right now, with rate cuts looming, the risk of underperformance is a growing possibility.
As such, we believe corporate bonds and other fixed-income securities are uniquely positioned at this time in the economic cycle.
From capital preservation benefits to a reliable income stream and enhanced diversification, there are various reasons to like corporate fixed-income securities.
If you are interested in learning more, speak to an adviser today.
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