What you need to know today about lowering interest rates

Lower interest rates may be good for some of us, but there is always another side to the story.

Understanding the basics of lower interest rates is as easy as ABC
A) Since the global financial crisis, central banks across the globe have kept interest rates at historically low levels in an attempt to stimulate economic growth.
B) While lower interest repayments have been beneficial to borrowers, the paltry returns available on holdings in low risk cash and fixed income assets has forced savers to look for other sources of income.
C) Both Australian and offshore investors searching for yield have flocked to higher risk assets paying substantial yields in an attempt to continue earning reasonable income returns on investments.

Local movement
The Australian share market has seen large flows into shares paying high and sustainable levels of dividends — typically the banks, utilities, telecoms and REITs sectors. The impact of the increased demand for high yield shares can be seen in the recent share price performance of the big four banks. During the first quarter of 2015, CBA, ANZ and Westpac set new all-time highs while NAB reached a seven year high and is the only one of the big four yet to recover to its pre-GFC high.

Relative to their own history, as well as other shares, all of the banks now look very expensive on the multiples typically used to assess their valuation.

What’s happening internationally?
Both in Australia and around the world, the performance of other traditionally ‘defensive’ high yield assets tells a similar story. Typically, REITs and listed infrastructure trade at a discount to the broader share market, but following the recent performance, these assets are trading at a premium to the share market indices.

The US Fed has indicated that the next move in US interest rates will be up. When this rate rise occurs, there is a risk that high yield assets will sell off sharply, particularly given their recent strong performance. These traditional ‘defensive’ plays must therefore be viewed with caution as they may not offer such ‘defensive’ characteristics.