Wednesday 09 May 2018
Federal Budget 2018: what it means for the market
Wednesday 09 May 2018
Keeping the crowd happy – a solid Budget
We review the Australian Federal Government’s 2018/19 Budget and assess its implications for the Australian financial markets. The table below highlights the key budget economic forecasts and changes since the Mid-Year Economic and Fiscal Outlook (MYEFO) in December 2017.
|Budget forecast changes||MYEFO forecasts 2018/19||Budget forecasts 2018/19||Direction change|
|Underlying cash balances (% GDP)||-1.1%||-0.8%||↑|
|Net debt (% GDP)||19.2%||18.4%||↓|
|Terms of trade||-5.00%||-5.25%||↓|
|Major trading partners growth||4.00%||4.25%||↑|
|Iron ore (US$/t)||$55||$55||→|
|Metallurgical coal (US$/t)||$120||$120||→|
|Thermal coal (US$/t)||$85||$93||↑|
Source: The Commonwealth of Australia (budget.gov.au), May 2018
- Last night’s Budget was mildly supportive for economic growth with improved revenues largely reinvested rather than saved, positive for consumer confidence via targeted tax relief, positive for the AAA credit rating via the expected earlier return to surplus and in turn positive for the sitting government in an upcoming election year. An all-round positive affair.
- The Budget took advantage of an improving revenue backdrop but with future spending largely conditional on a continuation of this path. It carried over last year’s move to leverage the balance sheet into infrastructure ($24.5b). Adjusting the low income tax offset (LITO) and unwinding the Medicare Levy increase offer a fillip for voters. However, the near-term economic gains are likely to be modest.
- Budgets tend to have only transitory impacts on the equity market with stock/sector positives and negatives usually offsetting each other. We don’t think this Budget is any different despite its uplifting tone and intent. We are not expecting a lasting tailwind for the financial markets and/or a sustained increase in confidence spreading through to spending and hiring, but on the positive side, neither has this Budget done anything to erode optimism.
- At a more holistic level, the 2018/19 Budget continued the trend started in 2017/18 of greater government involvement, stronger fiscal spending (infrastructure) and rising nationalism. We see Australia as pursuing a policy direction that is little different from the one being pursued by many other countries at a global level – a slight turn inwards and a focus on income distribution.
- We think the Budget was supportive for infrastructure exposed areas (engineering and construction) and ultimately the low end of discretionary consumer spending. The second round consumption impacts from stronger wage growth and business investment should flow through in time. See below for winners and losers.
Budget winners and losers:
|Infrastructure – $24.5b for transport projects with a focus on reducing congestion.||Black economy – taxing illicit tobacco and $10k cap on cash payments.|
|Boomers – +14k home-care places, expanded pension loans scheme and work bonus.||Gen Y/Z – no new major initiatives announced for education, housing affordability.|
|Low/mid income earners – low income tax offset (LITO) increase, 32.5% tax threshold increases to $90k from 1 July 2018.||High income earners - bracket creep adjustments are material but long-dated starting in 2022.|
|Healthcare – PBS listings, cancer screening, mental health funding, research.||Welfare – longer wait for foreigners, no increase to Newstart Allowance.|
|Small business – instant asset write-off extended.||Business taxes – tax cuts appear stalled, clamped down on R&D refunds.|
Source: Budget.gov.au, MWM Research, May 2018
Positives – modest near-term tax relief for low/mid income earners, further infrastructure investment and extending instant asset write-offs for small business were the major positives in the 2018/19 budget. Bracket creep changes were more material than expected (removal of 37% tax rate) which should, at least in the near term, boost sentiment. Retirees and the healthcare sector were the other major beneficiaries.
Negatives – Most areas of the economy were looked after given this was an election budget, but as always several sectors were left underwhelmed. Corporate tax cuts were included in the budget but appear stalled following the Royal Commission. Younger voters appear to have missed out with little new for education or housing affordability. Bracket creep adjustments are very long-dated. We saw no new initiatives that would boost Banks and Resources, the largest sectors of the Australian equity market.
Last night’s Budget capitalises on the recent bounce in revenues from growth in company taxes and employment, while reminding voters an election will be held in the next 12 months. It did not represent a meaningful loosening in the purse strings, such as the 06/07 Budget, but walks the line between balance sheet repair and a looming election with the harsh 14/15 Budget still hanging over the current Government. Pre-election budgets tend to support consumer confidence (see chart) and we see no difference with this budget. The issue will be whether the feel-good factor of announcing tax relief is reflected in the polls.
Sentiment boost typical for pre-election budgets
Source: FactSet, MWM Research, May 2018
The primary aim of returning to a headline surplus continues to underpin spending expectations. We flag that the budget forecasts are, as usual, likely to be on the optimistic side. This leaves the forecast deficit trajectory vulnerable to potential downgrades over the coming year if commodity prices weaken further, wage growth expectations do not eventuate or operating conditions do not materially improve. That said, the rolling upgrades seen in the last few forecast updates and the move to an earlier 2019-20 surplus, albeit marginal, should be welcomed by rating agencies with only S&P maintaining a ‘negative watch’ ahead of the budget.
Revenue boost drives further upgrades
Source: Treasury, MWM Research, May 2018
Treasury’s updated economic forecasts overall look sensible. Our main quibble is the forecast for wage growth to return to 2.75-3.25% in the next few years. The US$0.77 Australian dollar exchange rate is also well above current levels ($0.745). Commodity forecasts are conservative with iron ore at $55 a tonne. Household consumption will receive modest support from the near-term low-income tax relief.
Equity market implications
This was first and foremost an election budget that is overall a positive for sentiment and hence the equity market. The three factors most crucial for the outlook are support for consumer spending, policies to support jobs and income growth, and confidence boosting measures that will help kick-start private sector business investment.
Policy proposals addressed each, but more incrementally than would result from a loosening of the fiscal strings. Proposed tax relief is material, but mostly back-ended and likely subject to revision. We see no immediate impact on the path for the AUD or inflation and hence interest rates. Slow wage growth and stretched households necessitate a gradual pace of tightening by the Reserve Bank of Australia (RBA). We think the overall tone of the Budget was positive for consumer and business confidence, but there was a lack of direct equity market implications – either positive or negative with corporate tax cuts, in train, but notably deemphasised.
The ongoing substantial infrastructure investment makes sense both politically and economically. Fiscal policy is playing a greater role in stimulating the economy via road and rail projects, smoothing the transition from the housing construction boom while reducing pressure on the RBA to cut rates further. This was another nation-building budget (‘jobs and growth’); while timing of projects is long-dated, this is not a negative given current work in hand. Congestion measures are positive for productivity growth and addresses the realities of population growth and an ageing population.
At an aggregate level the 2018-19 budget will have a negligible immediate impact on discretionary expenditure due to the limited size and scope of tax cuts – there is a risk that voters will ultimately be disappointed. LITO adjustments won’t be felt in pay packets while tax bracket relief is long-dated. Tax reductions for higher income households are not a vote winner in the current environment, evident in their phasing in from 2022.
As opposed to the prior year Budget where there was little to cheer about for the consumer (higher Medicare levy, rising university fees and a consolidation in welfare payments), this year’s Budget was relatively positive but likely too modest to have any material impact for retailers.
Above all, this was an election budget. Targeting illicit tobacco trade and R&D tax credits is unlikely to cost votes. This year was about boosting sentiment – the response in the polls will determine whether we have an election this year or next. Historically, the Australian equity market has underperformed leading into an election and delivered stronger returns following an election once there is more policy certainty (or conviction that the middle ground will be materially changed).
- Infrastructure splurge continues:The Budget was positive for the capex-related areas with further spending initiatives across the infrastructure spectrum likely to provide ongoing support for diversified engineers, suppliers, and infrastructure developers (non-residential). The government once again showed its strong intent to support infrastructure with an additional $24.5b to be spent, pushing the pipeline out further into the 2020’s. Major infrastructure projects announced included:
- VIC - Melbourne Airport Rail Link ($5b), North East Link ($1.8b), Monash Rail ($0.5b), Frankston to Baxter Rail ($0.2b).
- NSW - Coffs Harbour Bypass ($1b), Port Botany Rail Line Duplication ($0.4b), Nowra Bridge ($0.2b).
- QLD - Bruce Highway ($3.3b), M1 widening ($1b), Nambour Rail Upgrade ($0.4b), Brisbane Metro ($0.3b).
- WA - Metronet Rail ($1b), Perth Congestion Package ($1b), Bindoon Bypass ($0.2b), Bunbury Outer Ring Road ($0.6b).
- SA – Adelaide North-South Corridor ($1.2b), Gawler rail ($0.2b)
- TAS – Bridgewater Bridge ($0.5b), Roads Package ($0.4b)
- NT – Central Arnhem Road ($0.2b), Buntine Highway ($0.1b).
- Direct and indirect infrastructure related construction stocks are underpinned by a strong multi-year earnings tailwind that has been further extended by this budget. However, while the public sector pipeline is positive, continued outperformance of the capex stocks will also require some improvement in private sector investment and this is being held back by nascent income growth and/or a potential decline in the value of housing and wealth related discretionary outlays. Unlike last year, we are not expecting a material response from the capex-related stocks as expectations are already high and the infrastructure projects were pre-announced.
Building out the pipeline
Source: Macquarie Research, MWM Research, May 2018
- Consumer spending – modest support. Consumer spending has been on a mildly improving trend through 2018, supported by strong jobs growth and better household income growth. We don’t see the Budget, and in particular the low-income tax offset, as providing a particularly large short term tailwind, but it should be supportive for consumption given its proposed 1 July 2018 implementation. More broadly, our economics team think disinflationary and competitive pressures are likely to remain strong in retail and that a key uncertainty for consumer spending is how households react to slower growth in their wealth as housing prices flat line and equity market volatility picks up. It is expected that these will be modest headwinds as long as the improvement in household income growth is sustained until the flow through from tax cuts emerges. This suggests that the equity impacts for the spending related areas will remain muted, particularly as structural (consolidation) pressures play though.
Retail trade growth improving modestly
Source: FactSet, MWM Research, May 2018
- Onwards to the election – This Budget was about boosting sentiment ahead of the Federal election – the response in the polls will determine whether we have an election this year or next. Certainly, the election is shaping up as far more material for the Australia equity market than last night’s Budget. Unlike previous elections which saw minimal policy differences (governments were voted out so ‘me too’ sufficed), this election is set to be fought on after-tax benefits, particularly for higher income earners. Labor’s proposed changes to franking credits, negative gearing, capital gains tax and private healthcare premium growth would have an overall net negative impact on the local market, some of which has already been priced in. As such, while we think the Budget had minimal direct impact on Australian equities, the same cannot be said about the upcoming Federal election which is now firmly just around the corner.
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