It sounds unlikely, if not inconceivable, that the Reserve Bank of Australia (RBA) could cut the interest rate as early as May. But at least one leading economist thinks this is a real possibility!
This will be a double-edge sword for ASX investors. Falling interest rates are typically welcomed by the equity market but a counter-consensus move by the RBA would signal a worse than expected deterioration in the local economy.
This is why I think investors should be overweight stocks with a material exposure to international markets – particularly the US.
Why a cut could come sooner rather than later
While the market is pricing in an interest rate cut towards the end of 2019, UBS thinks our central bankers may be forced to move sooner as a series of recent economic data point to further slowdown in the Australian economy, according to the Australian Financial Review.
This includes a slump in consumer confidence to its lowest level in one-and-a-half years, a softening in the number of job ads, weakening capacity utilisation and expectations of further weakness in the housing market.
The employment rate might be high but consumers are worried they might be out of a job soon and would struggle to find another!
“We expect the RBA to shift further in a dovish direction, and introduce an easing bias at the May meeting,” UBS economist George Tharenou said in a note to clients.
“However, if the labour market softens earlier than we expect, and the consumer price index is low, we can’t rule out a Reserve Bank of Australia cut in May.”
A cut in May would also be unusual because of the expected federal election. The RBA is typically seen to be reluctant to make changes during an election due to worries that the move could influence voters.
The only time the RBA made a change to the cash rate was during the 2013 election, noted the AFR.
How to position your portfolio for a rate cut
Regardless of whether the RBA cuts in two months or six, the risk that our economy is poised to underperform its peers is growing.
Investors looking to weather the soft patch ahead should be underweight on stocks that have all (or most) of its eggs in the Australia basket. This includes the big banks like National Australia Bank Ltd. (ASX: NAB) and Commonwealth Bank of Australia (ASX: CBA).
Small caps also typically underperform in such an environment as most junior stocks are leveraged to the domestic market and lack defensive earnings qualities of their larger counterparts.
Stocks that are likely to hold up better are those with significant offshore operations and resources as their products are largely exported. Extra points if they generate a decent dividend yield too as that would be appreciated by the market in a low interest rate environment!
Industrial large caps that are also worth considering include packaging group Amcor Limited (ASX: AMC), plumbing products company Reliance Worldwide Corporation Ltd (ASX: RWC) and engineering group Worleyparsons Limited (ASX: WOR).
Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited, Commonwealth Bank of Australia, Reliance Worldwide Limited, Rio Tinto Ltd., and WorleyParsons Limited. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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