Part of the reason for the sharp advance in the banks and retailers is because both sectors fell heavily last year, challenged by cyclical and structural pressures, according to Hasan Tevfik, senior research analyst at independent research house MST Marquee.
“When something is exceptionally cheap, then you don’t need much good news. You just need less bad news for things to turn around,” the strategist says.
In the last week “less bad” had meant the news from the royal commission and the RBA“at least acknowledging the slowness in the economyand moving to a more neutral stance” on interest rates, he says.
In this kind of environment, “you don’t need earnings upgrades and you don’t need growth” to get a swift upswing in stocks.
Tevfik notes there could be more upside but cautions that investors would be wise to take a selective approach even to the cheapest stocks.
Investors should assess balance sheet strength and cash generation ability carefully before jumping in, he says. “What limits the death spiral is access to capital,” he adds.
“There are ‘cheap and nasty’ [stocks] and ‘cheap and not so nasty’,” the strategist says. Building materials group Boral would be in his “cheap and nasty” bucket while electronics retailer JB Hi-Fi would in the “cheap and not so nasty” bucket.
Ben Clark, fund manager at TMS Capital, says that lower interest rates are normally broadly welcomed by equity markets.
“Overall, for equity market pricing, it should be a positive. If you’ve got declining future interest rates, that’s normally supportive for share markets as the present value of future cash flows becomes more positive.
“Lower interest rates normally create a bit of price momentum in terms of analysts lifting their price targets on stocks.”
For the fund manager, some of the real winners when interest rates fall are the high-growth companies.
“There will be some companies that have offshore earnings that aren’t as exposed to a slowdown domestically. If we’re seeing weaker interest rates, they might actually benefit. Lower interest rates mean their prices become more attractive,” he says.
Shane Oliver, head of investments at AMP Capital, notes that revised market prospects for Australian interest rates have pulled down 10-year bond yields, which in turn has helped investors look more favourably on real estate investment trusts.
But he cautions that the market is pricing in an interest rate cut because the economic data has been quite weak, particularly for retail sales and building approvals.
“The Reserve Bank is only moving to a neutral bias because the picture has weakened,” he points out.
TMS Capital’s Clark makes a similar point about the potential downside when central banks start to lower interest rates.
“Declining interest rates can mean an economy is slowing, so there might be more question marks about what a company’s future earnings are going to be,” the fund manager says.
The same companies that get an immediate benefit from the prospect of falling interest rates are the very firms that are most susceptible in a slowing economy.
“Retailers are the obvious ones, as well as domestic businesses leveraged to the domestic economy,” he adds.
Tevfik points out that the broader background is that “Australia is going into a slowdown”.
Optimism around interest rate cuts is “not really justified,” the strategist says. “A rate cut would cause further misallocation of capital within Australia. I’m not sure that the people calling for a rate cut have really thought through the implications for the housing market.”