Strong demand for a bond offer has proved its value

Attractive investment opportunities are still on offer despite a challenging set of circumstances for investors.

It has been a difficult period of late for investors on several fronts. Geopolitical developments are front of mind and equity and bond markets have sold-off in the past month. Unsurprisingly, measures of volatility are rising across most asset classes. Gold has rallied and the oil price remains well supported. At the same time, central banks in the US and Australia are alert to the possibility that inflation will remain sticky.

An additional complication is that it has been hard to discern a strong signal from economic data of late. With financial conditions tightening and the impact of aggressive monetary policy cycles yet to be felt in full, it would be ­rational to think economies were very much entrenched in the “late-cycle” phase. But recent data cast doubt on that narrative (or at least its timing), with economic data in both China and US surprising on the stronger side of expectations. And in Australia, the unemployment rate continues to track close to multi-decade lows, challenging the signal from leading indicators of labour demand that have slowed somewhat in recent months.

Locally, new RBA governor Michele Bullock has been clear in recent communications that the bank has a low tolerance for any upside surprises on inflation. Unfortunately, the most recent set of quarterly inflation numbers delivered just that – an upside surprise. This has forced the market to reconsider the likelihood that the RBA resumes its tightening cycle with rate rise of 25 basis points on Melbourne Cup Day. Some economists are also contemplating the possibility of a second rise, either in December or at the bank’s first meeting for 2024 in February. It goes without saying that the prospect of further rate rises will reduce the probability that the RBA can tread the fabled “narrow path” and successfully achieve a material disinflation with only a modest rise in the unemployment rate. A harder landing is not priced into ASX earnings in 2024 and suggests a rather asymmetric risk profile to earnings estimates in the listed sector.

The good news is that attractive investment opportunities are still on offer despite a challenging set of circumstances for investors. At JBWere, our strongest conviction views are presently focused on Australian fixed income. Dynamics around the recent issuance of an Australian government bond with a maturity date of June 2054 and a coupon of 4.75 per cent revealed that we are not alone in that assessment.

JBWere chief investment officer Sally Auld. Picture: Ryan Osland

The Australian Office of Fin­ancial Management, tasked with the job of funding the Australian government, received more than $28bn of bids for this bond. In the end, it issued just $8bn. This was a strong show of support for Australian government debt by both domestic and international investors. High yields and a relatively strong fiscal outlook in Australia probably underpinned strong investor demand.

Government bonds aside, we continue to see high-quality Australian dollar floating rate credit as a key pillar of portfolios, given ­attractive yields in this sector. In recent weeks, investors have been able to buy the new debt issues of investment grade Australian corporates at yields somewhere between 6 per cent and 7 per cent. These are effectively equity-like returns on an asset class that ­historically delivers much lower levels of realised volatility than equities. So, in risk-adjusted terms, these investments are extremely attractive. And with the RBA tightening cycle not quite over, we think there is still time to benefit from the high yields on floating rate debt.

The attractive risk-adjusted returns on fixed income at present mean that the case for deploying new or additional capital into ­equity markets is more difficult to prosecute than was the case a couple of years ago, when rates were exceptionally low. However, it is a good time to be parsing your current portfolio. With economies probably in the late cycle phase, now is the time to be ensuring that existing equity exposures are ­focused on quality – companies with low levels of leverage, a supportive market structure, relatively robust margins and a man­agement team that has proven experience managing through the cycle. And for those investors looking to redeploy some capital within equity portfolios, we think the domestic energy and healthcare sectors stand out.

In summary, investors could be forgiven for thinking that economic, geopolitical and market dynamics have conspired to deliver lots of uncertainty and not much in the way of opportunity at the moment. But although circumstances are challenging, the silver lining is that Australian fixed income offers both a safe and high-yielding refuge for capital while we wait for more clarity about the outlook. The opportunity cost of not investing excess capital into equity markets at present is very low, especially while risks are biased to further rate rises from the RBA in coming months and earnings estimates are pricing in a soft landing.

Sally Auld is chief investment officer at JBWere.

Originally published as Strong demand for a bond offer has proved its value