Earlier this week, the Reserve Bank of Australia (RBA) decided to reduce the official cash rate by 25 basis points to 4.1%. While that's still high, it does signal that the RBA is now beginning to consider normalising interest rates to a lower level. Under these circumstances, some ASX shares could be the right investment.
First of all, lower interest rates should help increase the underlying value of most businesses because of how high interest rates act like gravity, pulling down on their valuations. A lower interest rate can help increase their valuations. As Warren Buffett, the legendary US investor, once explained:
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature…its intrinsic valuation is 100% sensitive to interest rates.
REITs and property businesses
Businesses in the property sector, such as real estate investment trusts (REITs), builders, and building products companies, have struggled amid the high interest rate environment.
The higher-costing debt has increased debt repayments, reduced demand for property, and hurt sentiment about the businesses involved.
With interest rates now seemingly on a downward trend, this bodes well for many businesses.
So, I'd be happy to look at property fund managers such as Centuria Capital Group (ASX: CNI) and Charter Hall Group (ASX: CHC), REITs such as Centuria Industrial REIT (ASX: CIP), Charter Hall Long WALE REIT (ASX: CLW), and Rural Funds Group (ASX: RFF), and building product companies like Brickworks Ltd (ASX: BKW).
Retail
Many retailers' share prices have already risen in the last year or so in anticipation of interest rate cuts. But now that the rate cuts have actually started, they could help struggling households (and financially secure consumers) by enabling them to spend more at different retailers and boost their profits.
I think many ASX retail shares could benefit directly and indirectly from the lower rates, though their share prices have already risen to largely reflect the improved outlook.
Some of my favourite retailers include Wesfarmers Ltd (ASX: WES), Temple & Webster Group Ltd (ASX: TPW), and Nick Scali Limited (ASX: NCK). However, I wouldn't say their share prices are the most appealing valuations of the last 12 months. There could be a better price in the medium term. Metcash Ltd (ASX: MTS) looks cheap here, particularly with a possible rebound for its hardware division's earnings.
Asset discounts
I think some businesses are trading at lower valuations than how much they may actually be worth, or how much it would cost to replace them. Falling interest rates could make those assets seem more appealing, closing up the share price to a valuation discount (a bit).
I'm thinking of ASX shares like APA, Brickworks, Bailador Technology Investments Ltd (ASX: BTI), and Premier Investments Ltd (ASX: PMV) (due to its large holding of Breville Group Ltd (ASX: BRG) shares).
