Futures traders are ramping up bets on an October RBA cash rate cut

What are the best dividend shares to buy?

a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

sdf

Famous investors such as Warren Buffett and Hamish Douglass regularly talk to the media about why they believe interest rates are the key driver of whether share markets are good value or not today over the short term.

If interest rates go lower then the returns on risk free debt or cash like securities also go lower, which means the potential growth and yield available from equities becomes more attractive to investors. 

In part this is because investors demand less compensation (via lower share prices) for buying risky assets like shares before buying lower risk assets like sovereign paper or money market securities.

Equities are also valued by taking the present value of future cash flows discounted backwards by the assumed risk that those cash flows may not materialise.

The higher the discount rate applied to the future cash flows the lower the net present value of the future cash flows, but as risk free rates fall analysts tend to lower discount rates as debt is cheaper and liquidity more plentiful due to stimulatory policy. In Australia some commentators are even claiming the RBA may be forced into some sort of quantitive easing soon enough where liquidity is literally pumped into the economy by the central bank.

More specifically local cash rate futures traders have been lifting bets all month that the RBA is set to cut cash rates 25 basis points to 0.75% on October 1. 

As at September 20 the ASX 30 day cash rates futures contracts were indicating an 82% chance that the RBA will cut next week. On September 11 the odds were just 33% on a cut, with last week's weak jobs data the catalyst for larger rate cut bets.

In response the local share market is up 0.4% at 6,760 points today and near a record high as investors bid dividend favourites like Sydney Airport Holdings Ltd (ASX: SYD), Transurban Group (ASX: TCL) and Charter Hall Group Ltd (ASX: CHC) higher. 

In fact the high valuations of these equities today should be a warning sign to investors as the low yields offer little compensation for the risk being taken on.

As such the ultra-low cash rate environment is inverting the economic orthodoxy in an investment world where bonds are now bought for capital gains and shares for income.

I would not suggest buying shares for income though as it's fraught with risk if you insufficiently consider the risk of capital losses burying your income.

For example a business like Telstra Corporation Ltd (ASX: TLS) has been forced to slash dividends recently as average revenue per user (ARPU) falls across its product offerings and the NBN leaves a huge profit hole. 

I'd only ever buy a stock for income if I were happy to buy it if it didn't pay a dividend at all, but just bought back shares for example.

The challenge then is to find the right businesses with a few that come to mind being Bapcor Ltd (ASX: BAP), Accent Group Ltd (ASX: AX1), Scentre Group Ltd (ASX: SCG) Washington H. Soul Pattinson Ltd (ASX: SOL) or Sonic Healthcare Ltd (ASX: SHL). 

Motley Fool contributor Tom Richardson owns shares of Accent Group.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited, Telstra Limited, Transurban Group, and Washington H. Soul Pattinson and Company Limited. The Motley Fool Australia has recommended Accent Group, Scentre Group, and Sonic Healthcare Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Share Market News

Six smiling office colleagues stand in a row and look at the camera.
Broker Notes

Brokers name 3 ASX shares to buy today

Here's why brokers are feeling bullish about these three shares this week.

Read more »

A male investor wearing a blue shirt looks off to the side with a miffed look on his face as the share price declines.
Share Fallers

Why ANZ, Clarity, IGO, and Pilbara Minerals shares are dropping today

These shares are ending the week in the red. But why?

Read more »

Man drawing an upward line on a bar graph symbolising a rising share price.
Share Gainers

Why Betr, Centuria Capital, GR Engineering, and Mach7 shares are pushing higher

These shares are having a good finish to the week. But why?

Read more »

woman holding 'hiring' sign in shop
Broker Notes

How much upside does Macquarie tip for Seek shares?

The broker recently reviewed Australian job ad volumes for May.

Read more »

Ecstatic woman looking at her phone outside with her fist pumped.
Broker Notes

Macquarie tips 50% return for this cheap ASX All Ords stock

Let's see which stock the broker is feeling bullish about this week.

Read more »

A woman sits at her home computer with baby on her lap, and the winning ticket in her hand.
Consumer Staples & Discretionary Shares

How much upside does Macquarie expect for Lottery Corporation shares?

This ASX 200 stock has proven resilient through various economic conditions.

Read more »

ASX 200 retail shares a woman smiles over the top of multiple shopping bags she is holding in both hands up near her face.
Opinions

Up 90% in a year, is it too late to buy Zip shares?

Should investors buy this stock now or wait until later?

Read more »

Broker looking at the share price on her laptop with green and red points in the background.
Share Market News

5 things to watch on the ASX 200 on Friday

It looks to be a poor finish to the week for Aussie investors.

Read more »