The coronavirus may be causing havoc to global markets but it may also be about to make income stocks that much more attractive.
This is because the equity market meltdown is driving up the chance of interest rate cuts in Australia and the US. There's a surge in market expectation that the Reserve Bank of Australia (RBA) will cut rates as soon as tomorrow.
Falling rates typically bolster risk assets and it's ASX stocks that pay a decent dividend that are likely to benefit the most in this round. I'll explain why in a minute.
Twisting the RBA's arm
The loss on the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is set to deepen this morning as key international stocks indices continued to tumble on fears that the virus outbreak will trigger a global recession.
Our market crashed around 10% and that is just in one week! The speculation is that the speed of the correction will force the RBA (and the US Federal Reserve for that matter) to shore up confidence in the economy by cutting rate.
The market is pricing in a near 88% chance that our central bankers will lower the cash rate to a new record low of 0.5% at 2.30pm tomorrow. The probability was just 18% before, according to the Australian Financial Review.
US Fed may make bigger cut
A more dramatic picture is emerging in the US. CNN reported that the market is pricing in a 100% chance that the Fed will cut rates by 25 basis points in March and a 52% chance its chairman Jerome Powell will announce a 50-basis point reduction.
And in case you are wondering, the chance of a 25-basis point cut was 11% a week ago.
Economists believe that rate cuts won't help the real economy much and that government stimulus would be more effective.
How a rate cut will impact on ASX shares
I agree but this won't stop the RBA or Fed from cutting as they need to be seen as doing something. Also, while the rate cut may not prompt Joe Blob from going out to spend, it will make dividends from ASX shares look that much sweeter.
This is more so than so-called growth stocks such as WiseTech Global Ltd (ASX: WTC) and its cohort of high-flying tech darlings. If there isn't much confidence about global growth from rate cuts, investors will remain wary of stocks promising big profit increases.
Income stocks on the other hand are a different matter. Investors don't buy them for growth (not primarily) and these tend to have mature businesses that spit out a lot of cash – more than management needs due to its relatively muted growth plan.
Income stocks for the watch list
The big banks like Australia and New Zealand Banking Group (ASX: ANZ), utilities like APA Group (ASX: APA) and even big miners Rio Tinto Limited (ASX: RIO) come to mind.
Miners may benefit from high commodity prices, which require economic growth, but producers like Rio Tinto are sitting so low on the cost curve that it will make a very good margin even if the iron ore price corrects further. Also, the cash that Rio Tinto is producing far exceeds its capex requirements.
Ironically, the bigger near-term risk to markets at this point is not from the coronavirus but if the market got the RBA and Fed wrong.
