MARKETS SPECTATOR: How to reap the rate rewards

The market is expecting Australia's official cash rate to reach 53-year lows. But picking the stocks most likely to benefit may not be as obvious as it seems.

With interest rates heading for record lows, it’s time to load up on ravaged retail and housing stocks.

Following Tuesday’s surprise interest rate cut, which takes the official cash rate to 3.25 per cent, the ‘record low’ call for rates is ringing louder and louder. In fact, according to credit markets, which accurately picked Tuesday’s cut, rates are going to fall to the lowest in the RBA’s 53-year history. As you can see below, this market is currently pricing in a 74 per cent chance that rates will be 2.75 per cent or less by February 2013.

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So assuming this plays out, the big question is which stocks will benefit the most?

Traditionally the banks have done well during times of declining interest rates as they benefit from increasing net interest margins. However, due to the huge demand for high yielding assets recently, from both domestic and offshore money, Australian banks are valued towards the top of their range, on a price to book basis. So whilst dips are likely to remain shallow, there will be some reluctance from the big end of town to bid the banks much higher.

Rate cuts of this magnitude will almost certainly boost the subdued housing market and in turn the related stocks. We’ve already seen some strong moves among those stocks leveraged to this space. Since Monday’s close, CSR, which is seen as the most leveraged to the domestic housing market, is up 7.7 per cent while the likes of James Hardie, Fletcher Building and Boral are up 5.2 per cent, 4.8 per cent and 3.7 per cent respectively.

Whilst these stocks have had sizable moves from their lows, they are still way below their historical highs, which gives them plenty of room for further outperformance.

Besides the obvious increase in disposable income levels, which naturally boosts the retailers, rising house prices should also help the so-called ‘wealth affect’. Investopedia describes the wealth affect; when the value of property or stock portfolios rise due to escalating prices, investors feel more comfortable and secure about their wealth, causing them to spend more.

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So given the increase in consumer spending, the scrap heap that resembles discretionary retailers would definitely be a place to look. As you can see above, the sector is up 2.8 per cent and is the best performer for the week. More specifically, JB Hi-Fi, Myer and Harvey Norman are up 9.7 per cent, 6.4 per cent and 2.3 per cent respectively.