Why I’d buy cheap shares now before a massive market shift

Jon Smith outlines how a sharp fall in interest rates could be a catalyst for a market rally and why he’s buying cheap shares on that basis.

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There’s an interesting theory floating around at the moment about how a large stock market rally could happen next year do to a sharp fall in interest rates. If this is the case, adding cheap shares to my portfolio now could be a good move.

Big change ahead?

Over the past 18 months, interest rates around the world have risen sharply. Here in the UK, the base rate has gone from 0.1% during the depths of the pandemic to 5.25% now. High interest rates aren’t usually a good thing for the stock market. This is because it increases the cost of debt for large corporations. Further, it raises the benchmark of expected returns for an investor. If a Cash ISA can offer 5%, this suddenly becomes the return that has to be beaten to justify investing in a stock.

Despite all of this, the FTSE 100 has managed to push to fresh all-time highs earlier this year. This shows that fundamentally there’s growth potential.

The idea for a large reversal in sentiment hinges on a drop in global interest rates in 2024. The drop in inflation in the UK to 4.6% could be continued early next year. If it gets down to the target level of 2%, I’d expect the Bank of England committee to start cutting interest rates.

The benefits to the market

This would ease pressure on consumers and businesses alike. Given how quickly the base rate moved higher, I don’t think it’s out of the question for a quick fall down to 3% or 3.5% over the next year. This is what I believe would be the catalyst for pushing the FTSE 100 significantly higher.

It would also likely coincide with a spurt in economic growth, a stronger property market and higher disposable income.

The risk to this view for the UK would be political uncertainty via the general election, which is possibly due in H2 2024.

The action plan

Should this be the case, it makes sense for me to buy cheap shares now. Some would argue that “a rising tide lifts all boats” and that it’s easier to simply buy a FTSE 100 tracker fund.

I disagree. I’d rather be selective and buy cheap individual shares for a few reasons. To begin with, I’d much rather own a stock with a low valuation for the long term. If my view is wrong for next year and I buy an expensive stock, I could be left holding it for a long time without seeing any share price gains.

Further, if my view is correct, it’s the cheap shares that stand to gain the most. As investors pile in, the scope for an undervalued firm to rally is much more than a stock that’s already trading at 52-week highs.

On that basis, I’m filtering for stocks at 52-week lows with a price-to-earnings ratio below 10. This should provide me with a good list that I can then drill down into further.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jon Smith has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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