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All Ords Report 18 August 2015

Will the Reserve Bank of Australia (RBA) lower the cash rate again this year?

This is just one of the burning questions recently raised by a number of investors keen to gain exposure to the share market because cash isn't paying well, and shares are now trading at lower prices than they were three months ago. Regardless of which way the RBA moves you need to be aware how a change will affect you.

In my opinion, it is possible that we may see one further cut to the cash rate of either 0.25% or 0.5% this year, and I'm not expecting a reversal, or rate rise, until at least late 2016. If a further cut occurs it is important that you understand how the change will affect your cash or borrowings, and what it may mean for investments.

So for example, if the cash rate falls and you have your money in the bank your return will be cut, whilst borrowers reap the savings. Assuming the RBA makes one further cut this year of 0.25% before they put rates on hold, you can calculate how much you would be out of pocket, say for the next 12 months. Also, consider where you would be if the RBA cut by 0.5%.

If, on the other hand, you have a significant level of borrowings, a cut in the rate would give you a net benefit, and you can also calculate this amount. That said, of course there are no guarantees that the banks will continue to pass on the savings.

As I teach investors, never completely assume that the market will go the way your analysis indicates is likely. By the way, now is a good time to find out more about how you can learn to invest. Further, while you need to have a view as to which way the market will go, you also need to be prepared with a plan in case it goes the opposite way. Now, eventually the RBA will start to raise the cash rate and I believe the rise will be faster than the rate it has fallen.

The reverse situation will see savers benefit and borrowers wearing the pain, in having to pay out a higher rate of interest to their bank. But I expect this is unlikely before the last quarter 2016, which is a little over 12 months away. When it does rise though, the initial move is likely to be gradual, say around 0.25%, or 0.5%, and then we may see a more rapid rise occur in 2017. So what does this mean for investors?

With the cash rate so low, and despite recent share market weakness, I believe that money will continue to flow into shares, even if we see a 1 per cent rise in the cash rate in the next 12 to 18 months. For those of you who for the past few years have been sitting in cash, another year is a long time to wait in hope of a better return, particularly when inflation (currently at 1.5%) is eroding your return. Therefore, what you really gain when you leave your money in the bank is anything you receive above this.

What a low cash rate is really telling you is that this is not the time to have your money sitting in cash as money is more likely to continue to flow into shares over time, which means the current market decline is likely to be temporary. Of course when the cash rate is higher, say closer to 5 per cent, which would be many years away, and the share market were to fall, then at this time money is more likely to flow quickly back to cash. However, we are a long way from that situation occurring.

What do we expect in the market?

Last week, the Australian share market began trading in a small range above 5450 points, however, mid-week the Chinese elected to devalue their currency quickly which created waves on markets across the globe. The All Ordinaries Index (XAO) slipped below the 5400 support level to test the July 2015 low, which indicates that our market may trade lower over the coming weeks.

Perhaps your first thought is that the timing of the decision by the Chinese couldn't be worse, as the market was attempting to shore up its low in preparation for the next rise. However, during the formation of a market low it is possible for it to bounce lower to the next strongest support level so as to exhaust the selling, which is what I believe we are seeing. Remember, when the news appears to be at its worst, the bottom is nigh.

A further point about the Chinese situation is how the US have in the past tried to persuade the Chinese to completely float their currency against the US dollar. So, like our dollar, when the US dollar is rising, the Australian dollar generally falls and vice versa. The Chinese moved to artificially push the value of the Renminbi down, which would in theory attract investment, or prevent money from flowing offshore.

What is interesting is the timing of this event with Australia's decision to join the Asian Infrastructure Investment Bank as a prospective founding member. More than 20 countries have signed as founding members. Given the importance of our relationship with the Chinese I'm sure we will hear more on this issue in future.

My view on the market has changed slightly, however, the analysis still indicates that the XAO will be rising later this year, with the timing of a break above 6000 points to the original target, between 6200 to 6400 points, now likely in 2016. Over the coming weeks the market may move slightly lower, by around 3 per cent, to find support from one of the strongest levels created over the past four or five years at around 5200 points.

Dale Gillham is Chief Analyst at Wealth Within

All Ords Chart 18 August 2015

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