An investor’s perspective of the budget

Mon, 21 May 2018  |  

This article first appeared on the FIIG website at this link: https://thewire.fiig.com.au/article/2018/05/14/.Wv932WJ7Bn8.linkedin 

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An investor’s perspective of the budget

As some of the dust settles from Treasurer Scott Morrison’s budget, the clean air reveals the biggest issues boil down to significant cuts in income tax; an earlier return to surplus; and a path to lower government debt.

The government announced this seemingly incongruous policy mix – lower taxes and yet lower government debt – because revenue has been flowing into the Treasury coffers at a pace significantly above the level assumed in the mid year Economic and Fiscal Outlook update in December last year.

Lower tax and lower government debt are, at face value, good news. Most individuals would prefer paying less tax, while economic prudence and sound policy should see government debt levels reduced when the economy is growing at a decent pace.

But the good news on tax and debt is based on a number of premises that are open to debate.

The surplus forecast needs the economy to remain strong

Important to the analysis of the budget are the following assumptions from Treasury:

• The economy picks up steam and grows consistently by 3 per cent
• The unemployment edges down to 5 per cent
• Annual wages growth accelerates from 3.25 to 3.5 per cent

These favourable economic conditions are essential for the revenue inflow to remain strong enough to fund the tax cuts, see the budget return to surplus in 2019-20 and debt levels decline.

This may happen, of course, and no one is seriously forecasting a major slump in economic activity. Even so it was interesting that hours before Mr Morrison handed down the budget, there was news of yet another month of weak retail spending and further falls in house prices. There is also clear evidence that housing finance for both owner-occupiers and investors is in sharp retreat and this is before the latest round of credit restrictions take effect. Even a small undershoot in economic conditions, including perhaps GDP growth 0.5 per cent lower than forecast, wages undershooting expectations or commodity prices being below the Treasury assumptions will blow many billions of dollars away from the budget bottom line.

In this instance, the forecasts for a near elimination of net government debt by 2030 will be unobtainable and will require a new strategy if that objective is ever to be reached.

The minor parties in the Senate need to be convinced

One other risk is the Senate. With a diverse mix of minor parties in the Senate, there is a material risk that the tax cut legislation will be blocked or that the government will need to offer some potentially expensive trade offs to get the tax legislation passed. At the moment, the next tranche of the company tax cut legislation for medium and large businesses is being held up in the Senate and it’s unclear whether these cuts will become law before the election is called.

If the Senate remains a road block to the government’s tax plans, Mr Morrison and his colleagues will need to rethink their policy strategy, especially with the next election rapidly coming into focus.

Speaking of the election…

The budget is being described as a pre election budget largely because of the income tax cuts and promises of infrastructure spending. The government is hoping the electorate responds positively to these initiatives. But beware, the election looks likely to turn into a bidding war for our votes. Not to be outdone, the Labor Opposition is ramping up tax policy as a key aspect of its attempts to appeal to the electorate.

It is proposing bigger income tax cuts than the Coalition for low and middle income earners and has committed to extra funding for health and education. It is paying for these commitments by opposing the company tax cuts to medium and large business and looking to raise revenue from a range of tax reforms that will coincidently have a material impact on investment strategies.

The election could impact how and where you invest

It’s been well documented that Labor plans to change negative gearing rules by limiting tax deductions for investment properties to newly built properties. At the same time, its proposal to change income tax refunds to individuals from fully franked dividends will likely discourage investment in the high yielding, fully franked ASX-listed companies. It is also planning to change the rules surrounding capital gains tax concessions, a policy that will deliver more revenue to the budget.

As a result of these changes, a Labor win at the election will no doubt see investors adjusting their asset allocation in their investments, with negatively geared established dwellings and high yielding stocks less attractive.

Open the door for fixed income?

One asset class has been gaining greater attention in recent years is higher yielding fixed income. At a time when the economic cycle is moving against property and the stock market is fragile, relatively low risk, high yielding investments are a sound part of any portfolio. With corporate borrowing set to increase in line with the probable lift in non mining business investment, corporate debt issuance is likely to rise at a time when the asset allocation shift will be unfolding.

Tax Plan A versus Tax Plan B

The budget sounded the starting gun for the election. Both sides of the political fence will be offering income tax cuts, albeit targeted to different income scales and different constituents in the electorate. Labor will be collecting more revenue from tax changes in areas where the Coalition is strongly opposed.

One thing both sides can agree on (and it is actually a welcome big picture policy issue) is a pledge to deliver budget surpluses and lower government debt. Both sides will however, be banking on future solid economy growth in order to implement planned policies.

Investment strategies for individual investors may need to be revised depending on which side wins, with traditional negative gearing of property and investing in high yielding stocks moving out of fashion if Labor wins. Either way, the good news is that there are income tax cuts, budget surpluses and lower government debt, which most people would agree is a good policy prognosis.

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For the last year or so, it has been obvious to anyone with an open mind that the economy is in trouble. Unfortunately, the government and the Reserve Bank not only ignored this growth slump, but they ran a propaganda campaign saying the economy was “strong”, that unemployment would keep falling and wages growth was poised to pick up.

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An update on my house price bet with Tony Locantro

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This article first appeared on the Yahoo Finance website at this link: https://au.finance.yahoo.com/news/house-prices-are-still-dropping-but-bottom-sight-210000929.html 

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An update on my house price bet with Tony Locantro

It is difficult to think of a bigger issue that gets Australians fired up than house prices.Regular readers will know that back in September 2018, I made a bet on house prices with Tony Locantro, a fired-up Investment Manager with Alto Capital in Perth.

Tony wont mind me saying this, but he is what is called an ‘uber bear’ on house prices – he reckons prices are grossly inflated and are overdue to collapse. On the other hand, I reckon there is a cycle and that after the surge up to 2017, house price falls were inevitable, but that the decline would last only a couple of years and would not be too severe.

The bet was framed around a peak-to-trough fall in prices of 35.0 per cent in either Sydney, Melbourne or the 8 capital cities measure used by the Australian Bureau of Statistics. If prices fell by more than 35 per cent at any stage from the peak until the end of 2021, Tony would win, if the fall was less than 35 per cent, I would win.

Simple.

That background is important because the ABS just released the official dwelling price data for the March quarter 2019.

In the quarter, dwelling prices fell 3.0 per cent in the 8 capital cities and dropped 3.9 per cent in Sydney and 3.8 per cent in Melbourne.