Fixed income or stocks: What to do, given the high interest rates around the world and the low risk premium?

First I apologize for the delay of the column this week. But I will explain that it was for a “good” reason.
This is because much has been said about thesuper wednesday”, in which we would have the monetary policy decision both here in Brazil (at least Copom) and in the United States (with the meeting of the FOMC).

But I actually understand that the nomenclature is wrong. That’s because we’ve had decisions about the benchmark interest rate in several other major countries around the world since last week — in fact, for me it should have been nominated for “Monetary Policy Super Week“.

It started with the European Central Bank on Thursday (16). As we pointed out in the previous column, although they are still facing the difficulties imposed by the sale of the Credit Suisse to the UBS (and all that this could mean for global markets), the board led by Christine Lagarde followed market expectations and raised interest rates by 50 basis points, taking them to 3.5%.

However, unlike the previous announcement, this time the ECB did not commit to new increases in the next meetings — even though this was the baseline scenario before the problems with banks around the world. The institution stated that it will continue to monitor macro conditions to base its monetary policy decisions in the future.

But, at the same time, Lagarde made it clear that inflation is still something that bothers the region, and did not abstain from reinforcing the chance of further increases in interest rates if the inflation rates do not show the dynamics desired by the members of the committee.

Basic interest rates rise across the world

And, in the following days, she was not alone: ​​Central Banks of several developed economies such as England, Switzerland and Norway reinforced the need to continue fighting inflation in their countries, increasing interest rates as priced by investors.

Graph 1. Basic interest rate in some of the main economies in the world | Sources: Bloomberg and Empiricus

O Federal Reserve it also did not “innovate” and increased the “Fed Funds Rate” by 0.25 percentage points, taking the basic rate to the range between 4.75% and 5%, the highest level since the mid-2000s.

According to Powell, the decision (despite being unanimous) included the possibility of a break in interest rates at the meeting.

That statement, along with the adjustments made to the statement — with the Fed switching from “that further increases would be needed to bring inflation to 2%” to “the Committee anticipates that some further tightening may be appropriate” — made for investors to consider a change in the institution’s approach to interest rates, contemplating that rate cuts would be closer to happening. At that moment, the main American indices moved into the positive field on the day.

But in the interview with journalists to communicate the collegiate’s decision, Powell pointed out that the Committee would be prepared to increase interest rates beyond what was initially foreseen if necessary. In addition, he stated that the base scenario of the FOMC members did not contemplate an interest rate cut in 2023, only from next year – as shown by the Dot Plot, or the map with the forecasts for the interest rate level that each member of the Fed believes to be appropriate.

Figure 1. Federal Reserve Members Dot Plot for Base Rate Level in 2023, 2024, 2025 and Long Term | Source: Federal Reserve

For 2023, the Dot Plot median still indicates that the Fed Funds Rate should end the year above 5%, with some members not ruling out the possibility of being closer to 5.5%. As for next year, a minority believes that it should remain below 4% at the end of the period, and only in 2025 that the perspective is for interest rates closer to 3%.

Until the next FOMC meeting, on May 2 and 3, Powell and his colleagues will not be able to accumulate much data for decision making – just the employment report and the March inflation numbers, released in April.

1Q23 earnings season should set the tone for the market

However, in mid-April the earnings season of the first quarter of 2023with the big banks being the first to report their balance sheets (which, I believe, may be the winners of this banking crisis that plagues regional banks).

But the other companies may show that the situation is not so positive, prompting a possible analysts’ review of this year’s earnings.

This week the Nike (B3: NIKE34 | NYSE: NKE) reported its balance sheets for the quarter ended in February and, even with revenue growth of around 15% (almost 20% when excluding exchange variation), the company had a drop of 3.3 percentage points in its gross margin and a 9% decrease in earnings per share when compared to the same period of the previous year.

That is: the profits that the market estimates for 2023 for the S&P 500, of US$ 220 per share, still seem a little optimistic to me with the macro worsening resulting from the episode with the banks. At current levels, we are still talking about a projected 18x Price/Earnings multiple, equivalent to an earnings yield of 5.5%.

With interest rates at 5%, the 0.5 percentage point risk premium of investing in stocks still seems very low to me. In this case, investment in short-term fixed income assets, such as SPDR® Bloomberg 1-3 Month T-Bill ETF (NYSE: BIL) or the iShares Short Treasury Bond ETF (NYSE: SHV) I still think they are good options for a period surrounded by uncertainties with very low risk.

For those with a greater willingness to risk, corporate debt securities (but with a maturity of less than 2 years) can also be an alternative for a little more return. ETFs like the Invesco BulletShares 2024 Corporate Bond ETF (NYSE: BSCO) and the Invesco BulletShares 2024 High Yield Corporate Bond ETF (NYSE: BJSO)which invest in securities of low and greater credit risk, respectively, may be those options for a gain slightly higher than those of the US Treasury.

But the percentage of capital here has to be low, given that in a scenario of greater problems faced by companies, it cannot be discarded and can impact these assets.

Enzo Pacheco He holds a degree in Business Administration from the Federal University of Espírito Santo and a postgraduate degree in Financial Market Operator from FIA. An enthusiast of the subject of “investments” — having been interested since his university days —, since 2017 he has focused exclusively on the analysis of international markets in the Empiricus series dedicated to this purpose (Investidor Internacional and MoneyBets).