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The Experts

David Bassanese
+ About David Bassanese

David Bassanese is one of Australia’s leading economic and financial market analysts, who has authored several investment books and works in a number of advisory roles.

David is Chief Economist at BetaShares, which involves providing economic and investment portfolio advice to both retail and institutional investors. David is also an economic advisor to the National Institute for Economic and Industry Research.

Prior to these roles, David was Economics Commentator with The Australian Financial Review, where is regular “Bassanese” column appeared three times per week, as well as monthly in Smart Investor Magazine.

David’s analysis and commentaries cover local and international economic trends, interest rates, the exchange rate, and share market analysis.

Prior to becoming a Fairfax business columnist in 2003, David spent several years in financial markets as a senior economist and interest rate strategist at Bankers Trust and Macquarie Bank. David started his career at the Federal Treasury in Canberra, after which he spent several years as a research economist at the Organisation for Economic Cooperation and Development in Paris, France.

David has authored two e-books: The Australian ETF Guide: cheap and easy investment strategies using exchange traded funds (ETFs), and The Australian Investor’s Guide to Asset Allocation.

David has a first class honours degree in Economics from the University of Adelaide, and a Master in Public Policy from the J.F Kennedy School of Government at Harvard University.

Will the RBA raise rates later this year?

Wednesday, April 18, 2018

Could the Reserve Bank be planning an interest rate hike later this year, perhaps on the day that traditionally stops everyone across the nation except those on the RBA Board – Melbourne Cup Day?

Maybe, just maybe.  

Indeed, just when every economist around the country was prepared to write-off yesterday’s release of the RBA’s minutes from its recent policy meeting as nothing new, the Bank saw fit to drop an added line into the commentary – and one that Governor Lowe has been at pains to raise in recent months.

Just so there’s no confusion, the Bank indicated “[Board] members agreed that it was more likely that the next move in the cash rate would be up, rather than down.

What could cause the RBA to lift rates?  It was indicated in the very next sentence ”as progress in lowering unemployment and having inflation return to the midpoint of the target was expected to be only gradual, members also agreed that there was not a strong case for a near-term adjustment in monetary policy.

In short, what we’ll need to see is further declines in the unemployment rate – potential to around 5%, and ideally some lift in inflation to at least be comfortably at or above the RBA’s 2 to 3 % target band.  

Yet based on the RBA’s current forecasts, it’s still hard to see a strong case for a rate rise this year. In its February Statement on Monetary Policy, the RBA forecast the unemployment rate would end the year only a bit lower, at 5.25% (from around 5.5%), and that annual underlying inflation would hold steady at around 1.75%. 

Underlying inflation has averaged only 1.6% on an annualised basis over the past two quarters.

Yet the Bank only indicated it saw no need to lift rates in the near term.  What’s the near term?  One year, two years or six months?  It’s hard to know for sure.

One explanation for the RBA’s warning is that it’s very conscious that it has not raises rates in a very long time - seven years to be exact.  And so as the Governor himself acknowledged recently, when that fateful day does arrive it will “come as a shock to some people”.

What the RBA may be trying to do is jawbone very early to minimise this risk, or at least reduce the risk of any unwary borrowers taking on a lot of debt in the mistaken belief that interest rates will stay low forever. 

The RBA is telling us, ‘don’t say you weren’t warned”.

Along these lines it’s also likely that the RBA is very encouraged by the so far orderly correction in once red-hot Sydney property prices – even without it having to touch the interest rate lever.  It’s probably hoping this correction continues and it would be uncomfortable if cheaper prices and less frenzied buying conditions quickly goaded a lot more supposed “bargain hunters” back into the market.  Indeed, recent home lending numbers suggests there’s already been some stabilisation in investor property demand so far this year.

Supporting this view is the RBA’s willingness to warn of further property declines ahead. Indeed, in the minutes the Bank noted Sydney prices “had declined by a little under 5 per cent since their peak in mid 2017.” But it added “members also noted that declines in housing prices of around 10 per cent in some cities had occurred several times over the preceding 15 years.”

Of course, if the economy is stronger than expected this year, a rate rise is still possible – especially if higher US interest rates and weaker iron ore prices finally cause the $A to fall closer to around US70c.  But I’m still not counting on it at this stage. I still feel that despite the RBA’s recent rumblings, persistently weak wage growth and intense competition on retail prices will keep inflation contained and the Bank sidelined this year. 

The RBA is barking, but I still doubt it will bite anytime soon.

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Is Trump's 'trade war' careful economic planning?

Wednesday, April 04, 2018

It’s just as well that United States President Donald Trump is creating mayhem for markets with his erratic Twitter outbursts and threats to the world trading system.

After all, this is preventing global equities from simply 'melting up' in what would otherwise be a purple patch for the world economy, given synchronised global growth, strong corporate earnings and still low inflation and interest rates.

Trump is providing pit stops for still doubting investors to get on board before the bull market roars ahead for another lap.

Of course, I’m being slightly flippant – but the fact is that were it not for the Trump tirades, global markets would still be looking for another excuse to pause for breath after a furious rally over the past year.

Indeed, for a brief moment in January, in light of the Trump tax cuts passing Congress, it appeared everyone was suddenly bullish and we were finally entering into a potentially dangerous 'melt up' scenario for stocks.

That eventually ended when we did get one (non-Trump) related macro scare two months ago –a surge in US wages growth in the January payrolls report.  

But the February report suggested that was just a rogue number and US wages remained fairly benign.  We’ll get an update on US wages for March this Friday, but I reckon they’re likely to remain contained due to reduced worker bargaining power caused by globalisation and technology. 

That brings us to Trump. Just when it seemed stocks would regain their mojo, the world’s most important person saw fit to escalate trade tensions through tariffs on steel and Chinese imports.

It begs the question: is Trump truly crazy enough to think he could win a protracted trade war (which he can’t), or is his merely part of a negotiating strategy to effect change his way – or at least be seen to be effecting change amongst his rust-belt support base?  

In a sense, Trump is right to target China – it’s been dumping its persistent steel glut on global markets for years, which has indirectly lowered global prices and hurt US producers. And American patents, brands and trademarks are routinely copied by Chinese producers in flagrant disregard for world trade rules. 

As have other Presidents, Trump could have ignored this – out of fear of upsetting China. Or he could have quietly sought legal redress through the World Trade Organisation – which might take years and achieve very little.

That’s not his style.  Irrespective of whether his concerns are sincerely held or merely political grandstanding, the WTO route could not achieve his aims.

But unless he is completely unhinged, he must also know a protracted dispute with China could sink stocks and the economy – and do more damage than good for him politically.

That’s why I suspect that – as we’ve seen with North Korea of late – he’ll soon try to open a dialogue with China on trade issues and attempt to claim at least some type of victory. 

As for this hardline advisers, they could be merely part of his attempt to make his threats appeal real.  

In short, to believe Trump will risk derailing the bull market and America’s glorious economic expansion with an escalating trade war (for marginal long-term economic benefit) is to believe he is truly irrational. That’s possible, but certainly counter to his career so far. We can fault his methods, but let’s not forget he is a billionaire and did win the US Presidency having never held political office in his life.

Assuming Trump’s not crazy, then it must be the case that this latest threat to the bull market will also soon pass.  That would then leave US inflationary pressure as the greatest lingering risk to the bull market – but a risk which I also don’t think will flash red until at least mid/late 2019 at the earliest.


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How will Labor's tax changes affect Australia?

Wednesday, March 21, 2018

There are many implications that arise from the Labors party's policy proposal to abolish the cash refunds on dividend imputation credits, though the overall effect on the share market and economy may not be as great as some people claim. 

For starters, Labor's desire to further tinker with the already overly complex superannuation system is further evidence that "regulatory risk" in this area remains a persistent problem for Australians trying to plan for their retirement.  

Simply put, no-one should rely on the current - admittedly still relatively favourable - tax treatment of retirement earnings to continue indefinitely.  The revenue cost to the budget as the population ages - not to mention other pressures on the budget - will simply prove too great over time.

Of course, we can complain loudly about this, but I fear it will be to no avail.  

Indeed, even before Labor let fly with its latest proposal, we know the Treasury was actively considering ways of reigning in the cost of dividend imputation.  

And even the Turnbull Government has not been above slugging retirees with higher taxes, though the $1.6 billion cap on super balances that can earn a tax free income.  It also lowered the amount of assets retirees can have before they lose access to the pension.

To politicians, Australia's retirement system is like a large piñata filled with revenue - and every now and again they belt it with a stick to draw out a few more dollars.

How will Labor's policy affect the economy? For starters, for the vast bulk of Australian investors, the benefits of dividend imputation credits will remain in place - as credits can still be used to reduce tax that would be otherwise payable.  

Even if we accept Labor's figures that cash refunds cost the budget around $5.6 billion a year, the total cost of dividend imputation credits is around $30 to 40 billion.  

So we're talking about a tax change that affects around 15% of the dividend imputation system.  What's more, some suggest Labor's proposed budget savings are likely an over estimate, as it ignores the probability that many investors will be able to restructure their finances to still make maximum use of imputation credits where possible.

One obvious move is it ensures any investments attracting dividend imputation credits are held outside of the $1.6 million tax-free super cap if funds are sufficient - as they can still be used to reduce tax payable elsewhere. 

Due to this limited impact, and the still attractive income returns available on Australian shares, I also don't buy the argument that Labor's proposed change will lead to drastic changes in savings behaviour.  

Some suggest, for example, that it will encourage more Australians to invest offshore, or invest in riskier high-yield bonds. Yet dividend yields on international shares are still generally a lot lower than in Australia, even without the benefit of dividend imputation. Ditto -the yield available on most even high risk corporate "junk bonds."   Emerging market and high yield global corporate bond exchange traded funds (ETFs) available in Australia currently offer a yield to maturity of just over 5%. 

What's more, even if investors did make the switch, it's not clear to me that investing in a diversified bond fund - even one exposed to emerging market or higher risk corporates - would be significantly more riskier for those in retirement than investing in equities. 

In terms of the economy, moreover, there's an argument that our system of dividend imputation may not be as favourable as some suggest.  

Sure, it does remove the double taxation of corporate profits. And it does mean investing in shares is attractive for many investors and thereby gives Australian companies a ready pool of available capital.  

But by making dividend payments so attractive to investors, it also effectively increases the "hurdle rate" required for companies to justify retaining profits and investing in further growth of the company.  

As it stands, dividend payout ratios in Australia are now relatively high by global standards.  

In a speech last year, Deputy RBA Governor Guy Debelle noted a lift in corporate conservatism in recent years and suggested "there appears to be a desire to have 'excess' capital returned to shareholders through buybacks and dividends, rather than utilising that capital for investment with uncertain returns." 


As regards Labor’s policy, however, its focus on abolishing cash refunds appears to be based on the argument that while corporate profits should not be double taxed, they should at least be taxed once. The current policy of offering cash refunds effectively means a chunk of corporate profits – paid to those without offsetting tax liabilities – is not taxed at all. 

The problem with Labor’s policy, however, is that by seeking to focus on cash refunds, it effectively discriminates against those retirees on still relatively low incomes that have benefitted from these handy ATO cheques – whereas those retirees with higher incomes and tax payable won’t be affected.  In that sense it’s unfair, as a few case studies in our national papers can attest.  

And the fact that other case studies reveal how generous the current system is for those retirees on high incomes does not negate this inherent new unfairness in Labor’s policy. 

All up, Labor’s latest whack at retirees only highlights the need for a complete review of Australia’s tax and retirement system to shore up its fairness and cost sustainability – rather than the current piecemeal “whack the piñata” approach.

Only in this way may retirees have greater certainty over the retirement policies they’ll face in the future. 

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Why we should abolish the company tax rate

Wednesday, March 07, 2018

Having supported the case for corporate tax cuts only a fortnight ago, I was intrigued by an intervention into the debate by none other than Magellan Financial Group’s Hamish Douglass this week at the Australian Financial Review’s latest Business Summit. 

Even more interesting was the response by the CEO of BHP Billiton Andrew Mackenzie sitting right next to Douglass, which only highlighted just how hard decent corporate tax reform in this country will prove to be.

To my mind, their exchanges only solidified my long-held view that we need to think much more boldly in Australia before it’s too late, and scrap the archaic concept of corporate income taxation altogether.

But first to Douglass.

As I’ve previously conceded, on balance the research evidence suggests that a corporate tax cut from 30% to 25% as advocated by the Turnbull Government would likely be a net benefit to the economy.  According to modelling, the net gain for gross national income of around 0.6% or $450 in per capita income. 

Fair enough, but Douglass reckons the change in tax rates would remain so relatively incremental that he doubted it would lead to much profound change in business behaviour – such as lifting business investment and (most critically) wages.  On that score, I’d have to agree.   Although on paper we’d all on average be a little bit better off, we’d probably hardly notice it.

Instead, Douglass’ idea is a dual corporate tax system which gives business the choice of either sticking with the current system, or accepting a cut in tax to 15% in exchange for giving up the ability to offer dividend imputation credits to their shareholders.

As Douglass noted, foreign companies – to the extent their shareholders are offshore – benefit little from the dividend imputation system. And these are just the companies Treasury modelling is counting on to lift investment in Australia as a result of a tax cut.  How much better would their response be if we offered them the chance to half their tax rate to 15%? 

Indeed, in today’s globalised world, dividend imputation is far less relevant in attempting to attract foreign investment.  What’s more, even the Reserve Bank is growing concerned that our thirst for dividends may be perversely hurting business investment to the extent it is encouraging many local corporations to distribute a lot more of their profits back to shareholders rather than keep as retained earnings.

Of course, Australian investors – especially those in retirement which are able to enjoy tax-free income (thanks to Peter Costello) – have grown to love the imputation system.  Not only are the dividends received tax free (up to a point), but the Australian Tax Office will actually send many a check for the tax paid by companies on dividends prior to distribution. 

Current estimates suggest the ATO is mailing out around $5 billion in cheques each year – unheard of anywhere else in the world.

All up, it may surprise some to know that because of our lovely dividend imputation system, the net revenue collected from corporate taxation (after tax saved from imputation credits claimed by dividend recipients) appears somewhere between one half to one third less than the gross corporate tax revenue reported in the Budget papers.  In 2016-17, even a conservative estimate would place the annual revenue cost of dividend imputation at around $20 billion. 

Based on Douglass’ suggestion above, he reckons the cost to revenue is closer to one half of gross corporate tax revenue, or around $34 billion last financial year.

So why not go with Douglass’s suggestion?  A journalist asked BHP’s Mackenzie (who had earlier waxed lyrical over the need to cut the corporate tax rate) before I had the chance.

And his response?

Words to the effect that.. “I don’t really want to get into that debate as I know many of my shareholders enjoy their imputation credits.”

In short, killing dividend imputation while keeping the current corporate tax system in place would appear to hurt too many investors – particularly retirees – who enjoy its benefits.

That’s why I reckon we need to leap frog the world and simply abolish corporate income taxation altogether – especially as it is increasingly easy to shift it to low tax jurisdictions around the world in any case.  Left with higher post-tax profits, companies would be left the choice to boost dividends to offset any loss of imputation benefits.

Meanwhile, it’s really hard for the rest of us to complain about the loss of imputation credits on company tax that is no longer paid.

How would be finance the net loss in revenue from zero corporate taxation, or around $35 b per year?  We could clamp down on the black economy though a move to a cashless society and then place a (small) tax on the trillions in electronic transactions each year.  We could also explore a simpler cash flow or domestically sourced revenue tax on companies, which could also better help claw back lost tax from Amazon, Google and Facebook who cleverly send most of their true profits offshore.

I agree with Hamish Douglass.  A cut in corporate tax rates to 25% is trivial and won’t shift the dial. We need to be far bolder.

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Company tax: Are the big corps cheating the system?

Wednesday, February 21, 2018

The debate over cutting company tax has received a lot of attention of late, with some good and some not so good arguments being put forth.

It’s time I guess that I chime into the debate and share with you my own opinions.

For starters, I think we should lose little time complaining about companies that legally avoid paying tax.  Let’s remember: company management have no inherent social responsibility to pay more in tax than they legally need to. Who would?

In fact, company management would seem to be obligated to maximise after-tax shareholder returns – and if they don’t, they should either be replaced by directors or that very company risks being taken over by enterprising raiders that will insist taxes are no more than necessary.

As Kerry Packer once famously said in 1991 (after an ABC report into his tax affairs) “of course I’m minimising my tax, and if anybody in this country doesn’t minimise their tax they want their heads read.”

What of the case of Qantas that was has been identified in recent weeks as not having paid tax in years?  The reality, as CEO Alan Joyce eloquently explained, is that it had accumulated tax liabilities from during the financial crisis that could be used to offset against any future tax losses for some time.

There’s no point complaining to Qantas about this – if you want to complain, direct your ire at politicians for potentially leaving the corporate tax code more lenient than it should be.  The same goes for global tech companies that still appear to all too easily legally minimise local taxes by recording profits in offshore tax havens.  It not their fault, it’s ours.

What then of the broader argument over whether corporate taxes should be cut at all – given some suggestions that it won’t do much to lift employment and wages, as politicians would have us believe.

On this score, the critics are on firmer, but still fragile, ground. The “trickle down” of corporate tax cuts to households is indeed long and tortuous.  And given the multitude of factors that can affect the economy over any given time period, it perhaps not surprising that it’s often hard to find strong historical or cross-country correlations between the behaviour of business investment and wages and the level and changes in company tax rates over time. No-one should expect to find such simple direct one-to-one correlations.

Instead economists try as best they might to allow for these myriad factors through broader (“general equilibrium”) models of the economy.  And according to Treasury, the best guess on this more rigorous basis is that cutting the corporate tax from 30% to 25% - even allowing for an  increase in personal income taxes to make up for the net revenue shortfall – is to raise the level of GDP eventually by 1%. 

Does this all go to foreign investors? According to Treasury, foreign investors do make off with 40% of this gain, leaving a net increase of gross national income (or “GNI”) of 0.6%.  But by the same token, our companies tend to benefit when other countries cut their taxes also. It’s a case of swings and roundabouts. And after all, its the boost to after-tax returns for foreign investors that helps generate the lift in local business investment and worker productivity that the tax cut is designed to achieve.

You may scoff at a 0.6% increase in national income. But it’s still better than nothing – and it does suggest that cutting corporate taxes (even in a revenue-neutral sense) is at least a net-benefit to the country. In today’s dollars, that equates to around $11 billion, or a $450 increase in annual per capita income.

What’s more, Treasury estimates suggest the vast bulk of this income gain accrues to households – through higher wages and employment – rather than shareholders.  But even here, I’d note most households are also shareholders anyway through the superannuation system.  

Is this the best use of tax payer funds? Some might prefer we throw even more money into health and education – but the international evidence that ever more bucketfuls of money in these areas leads to better outcomes is even more dubious.  Finland spend less on education and has better results than we do – while America spends more on health for worse results.

And like it or not, the competitive downward pressure on corporate tax rates across the world suggests we may not have the luxury to simply retain the status quo. The goal posts are shifting.  

Of course, I’d rather see a corporate tax cuts as part of a wholesale reform of company and personal income taxation – with lower rates and less exemptions, and also potentially higher tax rates on wealth and not just income.

And I’m also uncomfortable – as is Reserve Bank Governor Phil Lowe – that billions are being promised on future corporate tax cuts before we’ve really tackled our lingering budget deficit problem.  But if the choice is earmarking future revenue for tax cuts to boost economic growth - or throwing more into our already inefficiently run health and education systems - I’d still take the former over the latter.

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The bull market still stands strong

Wednesday, February 07, 2018

A lot of ink has been spilt over the share market rout in recent days and for the sake of completeness I guess of should offer my own perspective.

For starters, I agree with Peter that this is probably just a short-term market correction that will prove to be a good buying opportunity within weeks or months – if not days.  Indeed, in many respects this was the “correction we had to have.”

Of course, one often hears that markets are “overbought” or “oversold” in the short-term. What exactly does this mean and how can we tell? 

It basically means markets have rallied so hard within a few days or month that buyers are exhausted – many short-term traders are keen to take profits and new money is reluctant to get into the market unless prices drop back a little.

One common technical measure of this is known as the relative strength index or “RSI”. Without going into the details, this tells us that a market is overbought when it breaks over 70 or so, and oversold when it drops to 30 or less. As seen in the chart below, after a super charged lurch higher in stock prices during January, the daily RSI indicator hit almost 90 on Friday, January 26 – one week before last Friday’s rout.  Indeed, it was the highest RSI reading at least since when the late 1980s.

On this basis, the market was clearly “overbought” – big time. 

Indeed, we had a similar ugly decline in the market in August 2015, which at the time was blamed on China’s collapsing share market, Greek debt problems and concerns the Fed was inching closer to raising interest rates for the first time since the financial crisis (which it eventually did in December). Note, however, the market was much less “overbought” in 2015 than it was before this year’s rout.

In 2015, the worst of the rout was over within 5 days with the S&P dropping 11% (and the RSI touching and “oversold” 17).  The markets then staged a recovery before succumbing to a collapse in oil prices and European financial jitters in early 2016. Apart from tremors associated with Brexit and Trump’s victory, the market has since rarely looked back.

One take-away from all this is that the longer market rallies last, and the more that volatility is crushed to very low levels, then like a wound spring, the deeper and faster is the inevitable correction.  That makes sense: the more investors bet on low volatility continuing, the bigger the unwinding of positions needs to be when turbulence again rears its ugly head.

So where are we now? Following Monday’s market slump on Wall Street, the S&P 500 was down almost 8 per cent from its closing high on January 26 and the RSI had touched 30.  That’s still not as big as the 2015 share decline and given the extremely good market run with low volatility in recent months, chances are more pain will be needed in the short-run before markets are capable of stabilising.

Meanwhile, all market declines are driven by fears over the fundamentals – and its only if those fears prove misplaced are markets able to rebound. After all, if Europe and/or China did implode – as then feared a few years ago – market would clearly not have rebounded in the way they did.

Today the fear is that US wage and price inflation is finally taking off given tight labour markets, which if true would tend to suggest America’s long economic expansion is finally exhausting itself.  This would be a classic of end of cycle inflation burst – more reminiscent of the 1950s to early 1970s - that central banks typically feel the need to snuff out with higher interest rates, which inevitably creates the next recession and bear market in stocks.

That may well be what eventually kills this bull market – but due to extreme competitive price pressures, my hunch is that we’re still at least a year or two away from this possibility. Having spiked higher last month (partly due to statistical quirks and one-off factors), I suspect US wage inflation within the February payrolls report will ease back down again, providing some relief to nervous investors. And even if it did start to gradually creep modestly higher, it would be no bad thing if this helps support consumer spending (and in turn corporate earnings) whilst leaving consumer price inflation still reasonable well contained.

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A warning to central banks

Wednesday, January 24, 2018

To paraphrase a former United States President, today’s investors seems to have nothing to fear but that lack of fear itself.  At least over the short-run, this is very encouraging – but a lack of fear can lead to complacency and a build-up in excess risk taking as the International Monetary Fund has recently pointed out.

Like a tightly wound spring, the greater we wind it up today the stronger the eventual recoil maybe when things start to unravel.

While most investors direct their concern to equity valuations, these risks are building most notably in the (corporate) bond market.  Indeed, it turns out traditional global bond indices – the type typically tracked by active fixed income managers and exchange traded funds (ETFs) - may not provide as much downside protection in the next equity bear market as one might expect. 

First the good news.

In its latest economic outlook, the IMF upgraded its global growth outlook, reflecting accelerating growth in Europe, Japan and emerging markets and the recently passed US tax cuts.  Critically, business investment across the global is starting to pick up – reflecting a tightening in labour markets – which could help boost still flagging productivity and give the global economic expansion extra momentum.

The IMF expects the global economy will grow by 3.9% in both 2018 and 2019 after growth of 3.7% in 2017.  That would mark the best global growth outcome since the 5.4% in 2010 and 4.3% in 2011, when the world was just emerging from the financial crisis.

US economic growth is expected to step up to 2.7% this year after reasonable 2.5% growth in 2017.  In the Euro-zone and Japan growth is expected to ease modestly, but remain relatively robust (relative to their potential) with growth of 2.2% and 1.2% respectively.  

Growth in emerging markets is expected to accelerate from 4.7% in 2017 to 4.9% this year – even though Chinese growth is expected to slow – helped by major turnarounds in India, South America and the Middle East/Africa.

In terms of equity markets, the corporate earnings outlook remains robust. And while price to earnings valuations are above average in many markets, they’re not that richly valued compared to the still very low level of bond yields.   

Low interest rates have been an elixir that has help the global economy and equity markets stage an impressive recovery in recent years.

But low interest rates have arguably had even stronger and more insidious effects in the bond market. For starters, with central banks buying up government bonds and keeping interest rates quite low, corporate borrowing has exploded – enabling companies to leverage up and buy back shares (helping boost earnings per share growth) and also satisfy investor’s thirst for yield. 

In the United States, this has seen leverage ratios among major listed companies rise to near record levels.


Associated with this debt boom, the weighting of lower investment grade (e.g. BBB rated) corporate bonds in traditional bond indices tracked my both active and passive bond fund managers has increased.  Given these bonds tend to be less liquid in a financial crunch than government bonds or more highly rated corporate bonds, it can add to liquidity risk come the next downturn. 


Source: IMF

Around one fifth of the Bloomberg Global Aggregate Bond Index, for example, is now comprised of BBB rated corporate bonds. 

Another issue is the fact that emerging markets are, once again, being showered in cash. According to the IMF, non-resident inflows of portfolio capital into emerging markets may have reached around $300 billion last year, more than twice the total observed during 2015–16 and on par with the strong pace of inflows from 2010–14.  These strong flows into emerging market government and corporate bonds is probably one of the reasons the $US was surprisingly weak last year – to an extent the $US remains a ‘safe haven’ and so easily sold off as investors search for better yielding returns in riskier corners of the world.

Despite this debt build up, corporate and emerging market credit spreads remains very low – as would be expected given this has been a “demand” driven surge in bond issuance.

This is why central banks need to be very careful – but nonetheless resolute – in unwinding extreme monetary stimulus.  Their actions arguably helped the global economy get itself out of the last financial crisis, but if they’re not careful will help sow the seeds for the next one. 

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3 things that will affect the stock market in 2018

Wednesday, January 10, 2018

Apart from the usual “geo-political” risks that persistently swirl around financial markets, the fortunes of investors typically turn on more mundane macro-economic forces such as growth and inflation.

Heading into 2018, I’ve tried to identify the key economic issues which will have the most bearing on the local stock market. I’ve tried hard to keep the list manageable. Indeed, I’ve indentified three key factors.

Firstly, is the performance of the Australian economy itself. On this score, I don’t think we can anticipate any major change in the still relatively soft outlook for mining investment. And while the outlook for non-mining investment (i.e. in factories and offices) is improving, it’s unlikely to ramp up quickly this year. Instead, the main swing variable will be housing construction.

Although home building approvals appear to have passed their peak, it’s fair to say they’ve not so far slumped in the way many (including myself) have feared – indeed, they continue to show feisty resistance, as evident by the 11.7% rise in approvals in November reported yesterday, driven by another 30% surge in (volatile) approvals for apartments. Housing is unlikely to be a major contributor to growth or employment this year, but the economy’s downside will be protected is we can stave off the enviable building decline for at least another year. So far so good.


Another key swing variable for the economy will the fate of consumers. Again despite persistent hopes, I suspect wage growth will remain quite soft this year and house prices will be lot flatter – meaning household income and wealth perceptions will again be challenged.

Household Saving Ratio


Whether households keep spending- which is critical for the economy given this accounts for just over half of GDP – will in turn depend on whether they can keep running down their saving ratio. As evident in the chart above, consumer spending would have been a lot weaker in recent years were it not for reduced saving, but by late 2017 it appeared household’s recourse to this means of spending has been tapped out. What happens to the saving ratio in 2018 will be critical – my hunch is that it will flatten out, which will keep consumer spending relatively subdued.

Globally, perhaps the single biggest swing variable will be US wage inflation. Again momentum in the US economy remains fairly strong, and it’s likely the already low unemployment rate will ratchet down further – probably to below 4%. Whether the party can last will depend on whether this apparent labour market tightness leads to an upsurge in (still relatively dormant) wage inflation, which in turn would make the US Federal Reserve more aggressive about raising interest rates. A pick-up in inflation driven by capacity constraints is the greatest threat to the impressive US economic expansion and equity bull market.

My hunch is that we will see a moderate lift in US wage inflation – with annual growth in average hourly earnings rising from around 2.5% to 3% by year’s end. But that should still only support three to four US rate hikes, which won’t be enough to kill the economy. Higher wage growth meanwhile – implying better balanced income growth – should also support US consumer spending.

Last but not least is the outlook for iron ore and coal prices. Oddly enough, prices have been sustained over the past year by China’s attempt to clamp down on steel production, due to excess capacity and excess pollution. Given persistent underlying steel demand, this has boosted steel prices and the profitability of those Chinese producers who manage to avoid bureaucratic shutdown. It’s also supported demand for higher quality imported resources, such as from Australia.

How this dynamic plays out in 2018 remains to be seen. But to my mind, it still seems likely the overall negative demand effect of China’s steel slowdown will eventually outweigh the current positive “substitution” effect of cleaner Australian resource inputs replacing China’s dirtier local alternatives. That said, I’m no longer anticipating a major commodity price slump – rather an easing back in iron ore prices, for example, from current level of $75/tonne to $US 50-55. Along with still rising production volumes and lowered costs, that should still mean local miners can punch out decent profits.

Overall, I remain optimistic the mix of these variables can keep global equity prices aloft this year, but Australia’s market may well not be among the global leaders once again.

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Where the budget is heading

Wednesday, December 20, 2017

By David Bassanese

I’m starting to get a little peeved with the almost exclusive focus on long-term economic and financial forecasts by the Federal Government and the Reserve Bank alike. The reason is that they increasingly seem to leave our policy makers unaccountable for the results they actually achieve in real time. 

It’s a classic shell game – keep excitingly pointing to the future and hope the punters won’t notice the present.  

Take the latest Mid-Year Economic and Fiscal Review (MYEFO) from the Turnbull Government.  The headlines naturally focused on the near-term improvement to the budget bottom line, and the still reasonable prospect that the Budget could return to surplus by 2020-21. 

Indeed, the underlying budget balance will now be in deficit by “only” $23.6 billion this financial year, or around $6 billion less than expected in the May Budget. What’s more, the surplus in 2020-21 is now projected at a tidy $10.2 billion, or $3 billion more than expected in May.  

But rather than leave this money on the table for the Labor Opposition to promise spend (as it surely would), the Government is now hinting there’s enough fat in the budget projections to potentially fund another “milkshake and a sandwich”  income tax cut. We’ll likely hear more about this in the May 2018 Budget. 

That’s one immediate problem with long-term budget projections – in what appears a scorched earth policy to deny the Opposition any money to play with, Governments of the day are now quick to commit to spend anything that leave more than a threadbare surplus over the forward estimates. That’s despite the fact overall public debt is still elevated (at least by our own standards) thanks to the legacy of the financial crisis and a fall back to earth in commodity prices. 

Another problem is that the Budget projections naturally tend to improve over time – with little extra work by the Government – due to the magic of “bracket creep”, or the increases in average taxes faced by households as rising nominal incomes lift them into higher marginal income tax brackets.  Aiding this miraculous budget improvement is the assumption that the economy will automatically step up to an above trend pace of growth so as to eradicate excess unemployment within a few years.  How very convenient! 

As seen in the chart below, the “hockey stick” budget improvement forecasts are nothing new!  Yet especially over the past few years of commodity prices declines, these forecasts have proven woefully optimistic. 


I’m not suggesting these are not reasonable assumptions – after all we need to assume something and full employment is a worthy aspiration.  Rather my concern is that these projections – which are obviously subject to considerable revision - then tend to assume undue public focus, and seemingly let Treasurer’s off the hook for current economic conditions. 

Lost in all the Budget hype, for example, is the fact that the Government actually had to downgrade its economic growth forecast for this financial year.  While many are cheering the Government’s expectation for 3 per cent growth in 2018-19 (unchanged from the May budget), the Government now expects growth of only 2.5% this financial year (down from 2.75%) and after a woeful 2% growth performance in 2016-17.  

The 3% growth forecast in 2018-19 is certainly encouraging – but it’s still just a forecast. And the Government’s recent track record in predicting better times ahead has not be great. 

One clear risk to the economic forecasts is the fact the Government is still counting on a further run-down in household saving to support consumer spending over the next year or so, even though households appear ever more cautious about their finances, and should be even more frugal as the Sydney and Melbourne house price booms subside.  Judging by international evidence, I also still seriously doubt we’ll get any decent lift in wage growth anytime soon.

That said, at least one element of good news in recent Budget announcements is that we’ve not seen the downgrades to the budget outlook seen earlier – thanks to more stable commodity prices, and improved global financial markets.  But what China and the market’s giveth, they can just as quickly taketh away. 

Yet thanks to the magic of the persistently improving Budget projections, we’re now quick to use up any Budget windfalls even before they’ve been truly earned. 

Treasurers have become accustomed to simply focusing on this automatic improvement in the budget - as if it were their work – while downplaying short-run budget overruns and/or disappointing near-term economic growth.



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Banks a buy in 2018

Wednesday, December 06, 2017

Banks stocks seem a great buy in 2018. 

Don’t laugh – I don’t mean local bank stocks, but rather their global peers due to the divergent fundamental forces each are likely to face over the coming year.  The good news for local investors, at least, is that it’s never been easier to buy exposure to global banks on the ASX through international sector exchange traded funds (ETFs).     

Locally, the story is not so great.  Given the challenges that have faced the local share market in recent times it’s a shame from an investment perspective that the financial sector – clearly the most dominant on the market – must now endure another wrenching period of regulatory risk as a hastily organised Royal Commission starts its work.

We already know two things about Royal Commissions: they are colossally expensive for taxpayers, and very slow in reaching their conclusions.  And even then, Governments are under no obligation to agree to any of their recommendations.

In the meantime, we’re likely to get a plethora of speculative headlines over what new burdens may or may not be imposed on our major banks.  In a way, it will be a bit like the nervous wait the market endured as the Australian Prudential Regulation Authority deliberated over what new capital requirements to impose on the banks so as to make them “unquestionably strong” by global standards.   

As it turned out, APRA’s new capital requirements were not as bad as feared, meaning banks did not need to raise a whole lot more shareholder dilutive equity or slash dividends.  But overall, the financial sector is now trading at lower prices then when APRA finally declared its hand back in July this year.  Negative headlines over one bank transgression after another has not helped, nor has signs of cooling in lending to the property sector – thanks to APRA’s clamp down on investor lending and interest-only loans.

The shame is to the extent that certain problems have been identified in the banking sector, specific new regulatory changes could and should have dealt with them much more quickly and at less taxpayer cost.  The problem is that Labor’s call for a Royal Commission has proven so politically irresistible than no matter what the Turnbull Government did (even having a say over executive salaries and bonuses!) was going to be viewed as too lenient in comparison. 

In short, the growth opportunities in the local banking sector – especially also given the slowing in the important Sydney property sector – appear limited. That said, given the Bank’s still strong pricing power – or ability to price mortgages at a levels comfortably above borrowing costs – they should still be able to churn out healthy steady profits and dividends.  The Big-4 banks are really modern day utilities – good for income but not much growth.

The global banking sector, however, appears to have a more positive outlook – at least over the coming year or so. For starters, the profitability of global banks in general tends to improve as longer-term interest rates rise, and especially if yield curves steepen. There’s a strong positive correlation, for example, in the relative performance of global financials and US 10-year bond yields.  As a result, the winding bank of massive bond buying programs by the US Federal Reserve – and slowly but surely the European Central Bank – should help global financials in this regard.

 Love or hate him, US President Trump is also poised to unleash a massive tax cut package which will favour relatively highly taxed US sectors such as financials, and he’s still vowing to cut back on financial regulations.

Global banks went on a tear in late 2016 when bond yields last spiked higher and Trump came to power.  They’ve since kept pace with the global equity rally so far this year but are possibly now poised to enjoy a period of outperformance once again.       


Indeed, while there’s been a lot of focus on Australia’s low exposure to the booming technology sector – and mixed performance of commodity prices – another major factor behind the underperformance of the local market against global peers this year has been the underperformance of local financials versus global banks.   This drag on local relative performance does not seem like ending anytime soon.

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