RBA's historic rate cut sees market outlook improve

On Tuesday the Reserve Bank of Australia (RBA) decided to lower the cash rate by another 25 basis points, resulting in a new record low of 0.75 per cent. Before deciding to cut interest rates, the RBA considered the trend to lower interest rates globally as a trigger to boost the economy. Therefore, the current rate cut is designed to support employment and income growth, and to provide greater confidence that comes with having a stable inflation rate.

As it stands, inflation is likely to be a little under 2 per cent during 2020 and a little over 2 per cent into 2021. If we can maintain this level, the outlook for our economy is good and we can be somewhat optimistic about the future. That said, in recent months we have heard noise about a possible recession across global economies, so should we still be concerned?

Right now, the outlook for the global economy remains favourable and the US economy is not as bad as many have been touting. The US has continued to perform well and is in a good place, with moderate growth, a strong labor market and inflation moving back to the goal of around 2 per cent.

The Fed is expecting growth in the US of around 2 to 2.5 per cent this year, and does not expect a recession anytime soon. If the US shows more signs of economic weakness, then the Fed has ample room to cut rates more aggressively, unlike the RBA. In fact, since 2015 the Fed has raised rates a total of nine times to 2.25 per cent, and has only cut rates once by 0.25 per cent last month.

Economists view lower interest rates as the catalyst for growth, as it is expected to increase consumer spending and corporate borrowing, which, in turn, leads to greater profits and a growing economy. Lower interest rates also encourages consumers to borrow money to invest in property.

From a business perspective, businesses have better opportunities to finance operations, acquisitions and expansions, which, in turn, increases future earnings potential and higher stock prices. So, as you can see, there is plenty to be optimistic about, and while things may not be like it was during the boom times, it’s not all doom and gloom.

The downside of lower interest rates is that it’s challenging for banks to maintain profit margins. Indeed, the recent rate cut has resulted in Australia's big four banks reducing home loan interest rates with NAB down by 0.15 per cent, ANZ by 0.14 per cent, Westpac by 0.15 per cent, and CBA by 0.13 per cent. That said, I still like the financial sector given that it has been hard hit since 2015 and the banks are overdue for a rise.

Looking at the Australian sectors, everything is in the red, as predicted, with the market down for the week. Healthcare, Industrials and Utilities were the best performers down by around 2 per cent while the worst performers included Information Technology, Financials and Energy, which were all down over 4 per cent.

Looking at the top 100 stocks, Northern Star Resources is up over 6 per cent, followed by Atlas Arteria (ASX:ALX), Newcrest and Dominos all up around 1 per cent. It is not surprising to see both Northern Star and Newcrest in the top performers, as both are gold miners and when the market is volatile, many investors head for the perceived safety in gold. While I am not a big subscriber to this theory, I believe much of the move in gold stocks this week has more to do with the interest rate drop than the market falling.

The worst performers this week have been Boral and CSR both down over 7 per cent. While Boral has been bearish for quite some time, CSR has been looking very good up until this week, therefore, I suggest you keep an eye on CSR. Challenger and S32 were down over 6 per cent, and again both of these stocks have been bearish for quite some time, so it is no surprise they are falling heavily with increased market volatility.

So what do we expect in the market?

After travelling sideways over the past couple of weeks, the down move I have been expecting finally arrived this week. My target is for the All Ordinaries Index to fall to below 6,400 points, with my bottom target around 6,200 points. If the bottom target is reached, this is a 6 per cent fall from current levels and around 11 per cent from the all-time high that the market achieved in early August.

While it is possible the market could fall further, this is unlikely, so once again I want to remind everyone not to panic as the market is unfolding as expected. I anticipate that the market will fall over two to four weeks into my target level before it turns to rise strongly into Christmas.

Given this, my advice is to get prepared for the next bull run, as there are many great stocks that are setting themselves up nicely, which you will be able to get into at a cheaper price. As I have mentioned previously, I like the Financials, Energy, Healthcare and Materials sectors in the coming year.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also author of Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in book stores and online at www.wealthwithin.com.au