Why falling interest rates would be good news for most investors
While the timing is not yet known, one thing we can be certain of is that interest rates will start to come back down over the next year or two.
Most experts expect that rates will begin to fall by early next year and likely reduce by at least 1% to 1.5%, probably over an 18-month period.
This is a big relief for those with large mortgages and investment loans, but it is also good news for most investors.
How asset classes have performed over the past year
In fact, the past 12 months to September 30, 2024, have seen 20% plus returns for Australian shares and international shares.
The listed property market has also jumped 45% after a poor period when interest rates rose sharply in 2022 and 2023.
The fuel for this strong rally has been the expectation that interest rates will soon start to come down.
Even the Reserve Bank of Australia (RBA) trying to temper expectations of interest rate cuts until inflation is back within its target range of 2-3%, seems to be largely ignored by the markets.
Aussie banks performing strong
One of the strongest sectors in the Australian market has been the banks, with the big four up more than 25% over the past 12 months.
This is a little surprising given that banks earnings over the next few years are expected to be flat and, while they were attractive dividend stocks more than 12 months ago, they now have an average dividend yield similar to the rest of the market.
Shares also benefit from falling interest rates in several ways - particularly for high growth companies as their valuations will benefit from a lower future interest rate.
This has been evident particularly in the US share market with many of the large technology companies having gone on another great run. To an extent we've seen this with a few tech companies in Australia as well.
As nearly all listed stocks have some level of debt, they also benefit when rates come down and interest payments reduce. This in turn improves profit for the year.
Only the energy and materials sectors have been negative performers for 2024 due to the large fall in oil and iron ore prices.
Perhaps the share markets have run a little too hard on the expected interest rate cuts.
Asset classes to watch
One asset class that we see as benefiting from falling rates longer term is global infrastructure. Infrastructure projects tend to have higher amounts of debt, but the value of these projects increase as rates come down.
With the income levels from many projects being stable, the reduced interest cost increases profit and so we expect the value of many of these listed global infrastructure stocks to rise.
The fixed interest asset class is a little bit complicated, however some fixed interest funds also benefit from falling interest rates.
If you owned a bond that pays 5% for the next 10 years and the rate on 10-year bonds falls to 4%, the owner of the bond would receive more money if they were to sell than what they had originally purchased for.
Cash investments to fall
However, generally, as interest rates fall, so do the income returns of many cash, term deposits and floating rate interest investments.
This has been extreme for term deposit investors over the past decade, where the one-year rates that started at around 5% fell to less than 1% by 2022. We then saw it climb back to 5%, and will now likely fall back to around 3% over the next few years.
Overall, falling interest rates are good for most investors and property owners.
The expectation that we will see some significant interest rate falls over the next few years has no doubt already pushed the share markets along very strongly over the last 12 months.
Perhaps we will see a pullback in shares once the RBA starts cutting rates, but we will have to wait and see.
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