I think ASX retail shares could be a good place to invest right now for the medium term. This is because of how much further their earnings could recover and increase in the next few years.
Currently the RBA interest rate sits at 4.35%, which is putting strain on certain areas of the economy, particularly younger Aussies with mortgages.
Of course, taking heat out of the economy is exactly what the RBA is trying to do so that inflation slows down in Australia. In September, Australia's central bank said inflation was "still some way above the midpoint of the 2–3 per cent target range".
Image source: Getty Images
Pain for ASX retail shares
In its latest monthly rate decision (which held rates at 4.35%), the RBA noted the pain being felt in discretionary spending:
Earlier declines in real disposable incomes and the ongoing effect of restrictive financial conditions continue to weigh on consumption, particularly discretionary consumption.
Nonetheless, the RBA board says it has one key target:
Sustainably returning inflation to target within a reasonable timeframe remains the Board's highest priority. This is consistent with the RBA's mandate for price stability and full employment.
However, I think it's likely the RBA will decide to reduce the Australian interest rate. I'm guessing it could happen in the first half of 2025.
Rebound for discretionary spending?
I consider ASX mining and retail shares cyclical businesses. It can be a good idea to consider them when conditions are challenging, and share prices are low.
Twelve months ago, I was calling a number of ASX retail stocks a buy due to the tough conditions and the potential for a rebound. For example, since this article (published virtually a year ago), the Adairs Ltd (ASX: ADH) share price has risen around 115%, and the Nick Scali Limited (ASX: NCK) share price has risen more than 30%.
I'm not expecting strong returns like that over the next year. Past performance with (retail) shares is not a reliable indicator of future returns, of course.
While we've already seen strong rises from names like Adairs, Nick Scali, Universal Store Holdings Ltd (ASX: UNI), Temple & Webster Group Ltd (ASX: TPW), and Wesfarmers Ltd (ASX: WES), it would be a mistake to think the gains are finished.
For starters, the RBA hasn't even cut interest rates yet, so there could be upside for both investor optimism and earnings when that happens.
Plus, ASX retail shares are always doing their best to grow profit with initiatives like better product offerings, improved efficiencies and increased online sales. Even if the average Australian doesn't see an improvement in their budgets during FY25, the Australian population continues to grow, which means more potential shoppers for these businesses.
When the RBA eventually does cut interest rates, I believe ASX retail shares are primed to see an earnings boost. As I like to say, earnings growth should lead to share price growth over time.
