Australia’s official cash rate is now the lowest in history. In this article we discuss how low interest rates affect each sector of the Australian Stock Exchange.
Low interests are a negative sign for consumer discretionary as it means that the growth of the economy is slow. Consumers become selective about what they purchase and will deter spending on non-essential items. Consumer discretionary stocks suffer in low interest rate environments as individuals do not want to spend money when they do not have confidence in the economic future. In these economic climates, people save their cash or use extra funds to pay off their mortgage.
Stocks in the sector are seen as a good buy in lower interest rates as they are defensive assets. Investors like consumer staples when the economy weakens. These stocks are considered as safe investments in economic uncertain times and they also provide good dividends.
Energy stocks usually rise with interest rate which means that interest rate drops are bad news for this sector. The performance of the energy sector is closely tied to inflation. Rising interest rates also mean rising inflation so low rates will signify that inflation is low. If inflation occurs in the economy, then energy suppliers will pass on the increased cost to consumers. This leads to an increase in company profits. If the economy is weak, then oil producers cannot pass this onto consumers.
Falling interest rates mean that bank’s net interest margins are low. So this is a challenging time for banks to make profits. Banks make more profits when the interest rates are high.
Healthcare stocks perform well in low interest rats environments as they are seen as stable assets. In uneasy economic periods, they have steady streams of revenue and high paying dividends. Individuals will continue to use healthcare even when the economy is weak so a slowdown of growth is unlikely to affect this sector negatively.
Lower interest rates are a negative for industrial stocks because as the economy slows so does the demand for products which impact goods used in construction and manufacturing. Activity drops as companies hold off expanding. However, some defensive businesses in the industrial sector perform well in low interest rate environments such as waste disposal companies. Industrial stocks which have offshore operations will benefit from an interest rate cut as the exchange rate will be lowered.
Technology stocks usually benefit when interest rates are rising as it is reflection that the economy is stronger. Therefore, low interest rates are a negative for this sector as these companies put a hold on expanding their businesses.
Low interest rates are a negative for the materials sector. When the economy is weak, companies choose not to expand as there is less consumer demand. Decreased demand leads to decreased production so less material is needed.
Property trusts are very highly geared so high interest rates impact profits significantly. Therefore, low interest rates are a positive for this sector as debt becomes cheaper, these companies become more profitable. Also, this sector is seen as defensive so low interest rates can increase the popularity of this sector.
The communication services sector benefits from low rates as it is a service which consumers use in all different economic conditions. It is a defensive sector so does well in economic fragile times.
Utilities do poorly in high interest rate environments as they are highly leveraged companies. Low interest rates would impact this sector positively as this sector is also seen as defensive. When rates are low, investors are attracted to utilities as they provide a steady form of income when other asset classes are only offering lower yield.
Lauren Hua is a private client adviser at Fairmont Equities.
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