So, the RBA turned to quantitative easing - what does it mean for ASX small caps?

RBA’s quantitative easing package & interest rate cuts reduce value of keeping cash idle
Low interest rates have helped boost equity markets, especially tech stocks; and the run is expected to continue
But investors warned against avoiding the “Warren Buffet school” of valuation

What will yesterday’s RBA interest rate cuts and quantitative easing mean for ASX stocks, particularly small caps?

Yesterday, our central bank announced an unprecedented package in attempt to improve our COVID-19 hit economy including:

Slashing interest rates and the yield on government bonds to 0.1 per cent
A reduction in the interest rate on Exchange Settlement balances to zero
Purchasing $100 billion of government bonds of maturities of around 5-10 years over the next six months.

It also hinted more would be done if necessary, including purchasing more bonds.

And it reiterated that it expects rates to stay at these levels for the medium term (at least three years).

While the bank admitted the recovery was underway and expects positive GDP growth in the September quarter, it will take some time to reach pre-pandemic economic output and employment levels.

It said the package would lower financing costs for borrowers, lower exchange rates and support asset prices and balance sheets.

What RBA package means for ASX stocks

Lower interest rates and bond yields, which will happen from the RBA’s quantitative easing, mean there’s minimal return by sitting on the sideline.

This reality and the expectation rates won’t go anywhere soon has been pointed to as a good thing for stocks, particularly growth stocks.

Back in September, UBS suggested stocks, particularly “tech disruptors” benefit from low interest rates.

This is because it lowers the discount rate on all the future cash flows baked into valuations.

One example of a beneficiary stock is buy now pay later market leader Afterpay (ASX:APT).

Recently, UBS expressed belief that Afterpay’s price, then $90 per share (now touching $100 per share) was three times higher than it really should be — $30 per share.

However, as a tech disruptor Afterpay also fits within the category of stocks that will benefit from a low rates environment.

And with rates at record low, investors are valuing them on the basis of future revenues well in excess of what they currently earn.

Afterpay (ASX:APT) share price chart

‘Perverse position to take’

For a further perspective Stockhead spoke with Morningstar analyst Mark Taylor.

Taylor agrees low interest rates have been a driver to the equity markets.

“It has been a driver of the multiples across all sorts of stocks across the market,” he said.

But Taylor warned returns were no guarantee and investors had to do their home work.

“It’s kind of a perverse position to take. You’re just pushing yourself further and further out the risk curve into desperation for yield, which you’re not getting on the risk-free rate any more or interest rates aren’t providing for you,” he said.

“Our valuations aren’t going to change any time soon, we’re more of the Warren Buffet school where it’s the long term that matters.”

“We won’t be lifting our valuations, but the market may.”