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The political signs investors should heed

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The first and most irrefutable truth that comes out of the Wentworth by-election is that Bill Shorten is odds-on to win the 2019 election.

But the Wentworth by-election did show that there is at least one avenue where the Coalition can curb the ALP avalanche – the ALP franking credits mistake. But first, let’s conceptualise as to what a Shorten government may mean to Australia and to investors.

There is little doubt that overseas investors will be nervous and there will be pressure on the Australian dollar, but the local currency has been under pressure for a while and more than likely the global forces that exist around that time will have a bigger sway than the election.

There is also little doubt that the ALP government will let loose wage rise pressures and therefore lift the inflation rate and reduce the profits of companies that are managed in a way that is dependent on labour. My mates in the WA mining business say that already their labour rates are on the rise and they expect to be paying much higher wage rises even without Shorten.

Miners will need to invest much more heavily in automated equipment to nullify the effect of wage increases. And that is exactly what non-mining companies all around the land must now prepare to do. We have been talking about the next phase of the computer-internet revolution for some time. An ALP government will quicken the pace because It is likely that the inflation rate will pick up as part of the wage rise process.

Of course, with higher inflation will come higher interest rates. Those with property and infrastructure investments that are linked to inflation will welcome an ALP government. And it also applies to inflation-linked debt securities. On the other side, by mid-2019 the Australian housing market will almost certainly have fallen further and will be petrified about higher rates.
 

Managing the China relationship

Australia faces a very difficult situation in managing the China relationship because of our defence links with the US. The current government tends to favour the US against China. An ALP government is likely to lean more towards China than the Coalition, although once in office an ALP government will see an avalanche of pressures to tow the US line against China.

But my guess is that the pendulum will swing towards China and that is good for miners, tourism, education and other areas of Chinese activity in Australia.

At the moment China and Australia have one obvious thing in common – both economies are slowing down. China is fearful of any major slowdown because of the social implications. Already it is starting to stimulate its economy to increase demand. China’s greatest challenge going forward will be to boost local demand for goods and services in a way that offsets the reduced demand in the US and then perhaps from Europe. Australia has a big stake in that drama.
 

The franking credits threat

Back to franking credits and there is no doubt that one of the reasons that Kerryn Phelps did so well in Saturday’s onsite polling was the fact that her pre-election Friday message, where she advocated stability in Australian superannuation for the next five years, had seeped through into the electorate in Wentworth.

I have been writing about the devastating effect of the ALP’s franking credit policy on about 1.4 million Australians. Belatedly Treasurer Josh Frydenberg took up the theme on the Thursday before the election, but he didn’t take that all-important step in declaring that the Coalition would not change superannuation in the next five years.

Phelps read both my material and that of Frydenberg, and on the Friday – the day before the election – she announced her long-term savings plan for stability. Everyone could see that it was a winner.

The Liberals will need to get its act together in the coming months, but at last looks ready to take the ALP on in franking credits. If Wentworth is any guide, there is clear potential to reduce the ALP’s winning margin. I don’t think the politicians on either side fully understood that 1.4 million people are threatened by the ALP policies, including 800,000 who have their savings outside of superannuation. These are big numbers and it is vital that the Liberals mobilise them.

What I find amazing is that the ALP continues to stick doggedly to its statements, and it will gain great revenue from high-wealth individuals by its removal of cash franking credit entitlements. I am sure that statistically that conclusion is right but around the country high wealth individuals will change their investment strategies and priorities so that they generate taxable income and retain their franking credits. If you have sufficient wealth this is not hard to do. The ALP cash franking credit entitlement removal is not a tax on high-wealth individuals but a tax on the battlers, and as such creates a great opportunity for the Coalition.
 

Handling China’s economic impacts

Returning to China – on occasion after occasion in recent decades we have seem a looming downturn in the Chinese economy overcome by strong simulative measures. Accordingly, here in Australia we have become very confident that the Chinese have everything under control and will do whatever is required to stabilise their economy and maintain the demand for Australian goods and services.

And the recent actions by the Chinese authorities are in line with their past actions. But we do need to underline the fact that the Chinese share market as measured by the Shanghai Index is down by around 25 per cent. That is a big fall in anyone’s language, and falls of that magnitude normally hold back an economy.

But we are seeing a recovery in line with the stimulation. Australia will need to manage the China downturn at the same time as our self-inflicted domestic downturn. The falls in the value of houses are clearly now affecting retail sales and that effect will be multiplied as the squeeze on bank funding becomes more and more intense.

At some point our regulators will wake up that they have gone too far, but I don’t think that will happen until it is very clear that great harm has been done.

And that is the danger for Australia – the combination of the US driven China downturn and the local credit squeeze. It makes you think that 2019 may be a good election to lose, but no political party ever believes that.

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Robert Gottliebsen is a financial commentator at InvestSMART (AFSL 282288). This article contains general investment advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice. You should consider the product disclosure statement before making a decision about a product. This article does not reflect the views of WealthHub Securities Limited. The article was originally published on 15 October 2018.