The 0.25% cut saw the Australian stock market rally 1.5% on the day to 5707. Does this mean the market will stage a concerted rally on this news?
Difficult to say as many other events, both local and world can make the market go in different directions – local interest rates are but one.
However, focusing on just the interest rate cut, what are the immediate implications?
Let’s start with what RBA Governor Glenn Stevens said……..
“In Australia the available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak. As a result, the unemployment rate has gradually moved higher over the past year. The fall in energy prices can be expected to offer significant support to consumer spending, but at the same time the decline in the terms of trade is reducing income growth. Overall, the Bank’s assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet. “
He went on to say….
“This action is expected to add some further support to demand, so as to foster sustainable growth and inflation outcomes consistent with the target. “
Economics 101 says that the reason interest rates are cut is to stimulate growth as the economy is flagging. Glenn Stevens comments supports this. There are adjectives in this excerpt such as;
below–trend, weak, higher (unemployment), fall, decline, spare etc………
Not positive, are they? So if overall economic growth is below trend, then businesses will make less profits, (and employ less people), and the share price will not race ahead. So over the medium term, until the economy improves, one couldn’t expect the share market to improve markedly.
But why did it spike yesterday on the announcement?
Basically it’s the market making a short term assessment on specific stocks, such as companies offering high dividends and exporters set to benefit from a lower Australian dollar. Additionally retailers tend to benefit as there is a boost to consumer confidence.
However, the market had another rise on Wednesday but for a different reason – an increase in commodity prices thus as stated earlier, a one off event like an interest rate cut needs to work in conjunction with other positives to move the market, both short and long term.
Interestingly there has been some commentary that the tone of the RBA announcement suggests that further cuts may be likely. Thus the bond market (medium to long term interest rates) rallied downwards expecting further cuts.
Investing in shares based on one economic event is beneficial if you are on the spot (in front of a screen when the news comes through) and you already have researched what stocks will be positively affected by such a news event. That’s too hard for busy investors, so a well-diversified portfolio with stocks that generally rise on all good news and ensuring you aren’t overweight in a sector where bad news occurs (as seen recently in Energy), is generally the best approach.
And importantly, it is a long term focus you take because interest rates both fall and rise over an economic cycle.
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