One stock to buy, one sector to avoid as rates hit 4.6% - plus a contrarian RBA call

The cash rate is now 4.60% – its highest level since 2011 – after the RBA lifted rates another 25 basis points this week. And the central bank isn't declaring victory yet, warning it remains prepared to tighten further if needed.

Markets have taken the hint. Traders are pricing the cash rate above 5% by May next year, a scenario Governor Michele Bullock was directly questioned about following this week's decision.

So, what should equity investors actually own if rates remain higher for longer?

Two Australian fund managers are already adjusting their portfolios – while one fixed income heavyweight thinks the market may be getting the next move in rates completely wrong.

IAG: A rare beneficiary of higher rates

For Emanuel Datt, chief investment officer at Datt Capital, the latest hike means investors should spend less time trying to predict the RBA and more time finding the winners and losers.

“The latest RBA hike takes the cash rate to territory not seen since 2011, and the market’s job now is picking winners and losers rather than betting on direction.”

One potential winner is Insurance Australia Group (ASX: IAG), which offers a trailing yield of 4%, or 5.1% grossed up for franking credits, while trading on a price-to-earnings ratio of around 18 – below the broader market.

Unlike highly leveraged businesses that must absorb higher borrowing costs, insurers can benefit from higher rates through the returns generated on the enormous pools of money they hold before claims are paid.

“General insurers such as IAG are structural beneficiaries, given every basis point of higher investment yield on the float flows straight through to earnings.”

Small caps require a different playbook

NorthStar portfolio manager Claudia Kwan is also treading carefully, particularly at the smaller end of the market.

NorthStar's positive investment screen naturally gives its portfolio a small-cap tilt, making liquidity particularly important as tighter monetary policy works its way through markets.

Kwan says the fund has reduced its overall exposure to real estate investment trusts (REITs) and is being selective in healthcare, where some businesses are battling inflationary cost pressures.

Instead, she is concentrating on companies enjoying upward earnings revisions and positive near-term catalysts, while remaining constructive on resource commodity prices.

“We remain constructive on resource commodity prices and continue to invest in circularity, critical minerals and their supply chains, water and selected healthcare.”

What if the next big move is actually a cut?

Then there is Schroders' head of fixed income Kellie Wood, whose view on the RBA caught our attention for its contrarian nature.

While markets are pricing a terminal cash rate around 5%, Wood believes that pricing has “run ahead of the fundamentals.”

Schroders’ cash-rate model peaked at 4.75%, suggesting there may be room for one more hike. But crucially, those models have now begun turning lower.

Wood points to falling house prices, weaker housing lending and deteriorating business and consumer sentiment as evidence that higher rates are starting to bite.

“We believe the next meaningful move is a cut, and we expect the RBA to begin easing in 2027 as the inflation shock matures and the focus shifts to downside risks to growth.”

It’s a bold call given the RBA has just unanimously raised rates and explicitly kept the door open to further tightening. But the team at Schroders is looking beyond the hawkish rhetoric and sees downside risks building across the economy.

The dilemma for investors

For investors, a rising-rate environment can create a very different set of winners. 

Morgan Stanley recently argued investors should dump Australian equities and recalibrate portfolios for what it calls an “inflationary boom”. Higher yields make fixed income more attractive, while inflation-protection assets such as commodities, infrastructure, precious metals and floating-rate debt can also come into their own.

It's certainly interesting times ahead for Australian investors recalibrating their portfolios for a higher-rate world.

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