Rudd And The Markets

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By Greg Peel

Once upon a time it used to be accepted that a Coalition government was good for business and a Labor government wasn’t. Despite the fact that Labor has moved so far to the centre as to blur the distinction between the two, a far more interdependent global economy in the twenty-first century ensures that there’s not a lot Rudd can do to upset Australia’s growth story for the time being. Our economy, and subsequent monetary policy, is largely out of the government’s hands.

That is not to say that fiscal policy won’t be influential too. John Howard attempted to coerce the electorate into believing Australia’s current economic strength is all about his economic management, but a not so naive electorate saw through the argument and has long appreciated the effect of China’s growth. Realistically the Coalition added to inflation pressures, and thus interest rates, with its previous tax cuts, while Work Choices was potentially set to have a dampening effect on inflation.

Had the Coalition won the election then the further tax cuts and other fiscal handouts promised as a sweetener would have again proven inflationary, and thus likely to have placed further upward pressure on rates which are already under pressure from global influences. Rudd’s cuts and handout promises represent a smaller lolly jar – even to the point where Labor appeared more fiscally prudent and thus in contradiction to its socialist roots – but are still cuts and handouts nevertheless. Whichever party had won on Saturday, Australians would have still been looking at interest rate pressure from fiscal policy. This leaves industrial relations policy as the most influential point of difference.

Work Choices has been touted as one of the fundamental reasons the Coalition lost. Despite assertions from the government otherwise, Australian workers perceived they were worse off under the Coalition system of workplace agreements than they had previously been under the award system. If this is indeed the case, then a dismantling of Work Choices should thus return upward pressure to wage inflation. Australia’s wage growth has been running at a well-behaved 4% to date – a figure that has largely surprised the RBA. Australia is enjoying the lowest level of unemployment in decades, yet wages have not exploded anywhere other than in the mining sector. While productivity gains are evident, the RBA has remained on a vigilant watch against wage inflation, and has long suspected upward pressure is only a matter of time.

So the end result is a Rudd government is the lesser of the evils on direct fiscal stimulus through tax cuts, but the greater of the evils through industrial relations policy. However, there is a wider question, and that is: Has Rudd received a “hospital pass”? If the US heads into a recession then there is a chance the rest of the world will follow. If this is true then Rudd may not have to worry about higher interest rates for too long. He may, however, have to worry about growing unemployment. He has won government at a time when unemployment could not have realistically fallen any lower, so he is facing a bet-to-nothing prospect. You can just hear new Opposition leader [insert name] in parliament already, railing away with the told-you-sos.

And the same will be true if interest rates rise further, although the electorate, as suggested earlier, is now cognisant enough to realise interest rates are affected by strong economic growth, which in turn is affected by strong global economic growth. If rates rise with an additional element of tax cut stimulus, then Labor can always fall back on reminding of the Coalition’s more extavagant promises. Labor will take time to dismantle Work Choices, and in the meantime Australians will be spending their additional income and stimulating the domestic economy nevertheless. Macquarie economists suggest Labour’s tax cuts will equate to an income injection equal to 4.5% of GDP.

We are currently facing uncertain times. The bulk of global economists suspect that the US economy will slow to a crawl, but will not actually recede. This is due to the strength of the global economy ex-US, and a growing recognition that while the US economy is still by far the world’s largest, the Asian economies are rapidly growing domestically – at a faster rate than their export economies. On that basis, Asia should be dampened, but not overwhelmingly slowed, by a US recession. Thus Australia’s economy should also prove relatively safe.

But it’s all conjecture at this point. Back to the immediate effects. (For more on China and a US recession see “Why China Won’t Catch a Cold”; Sell&Buyology; 23/11/07)

Macquarie economists have turned their focus on tax cut stimulus. “In this environment,” says Macquarie, “only the strongest franchises are likely to make significant
EPS growth headway at a time when earnings downgrades are likely to be the norm for most of the market given the intensifying cost squeeze now underway”. This statement was made prior to, and regardless of, the actual election outcome. Thus the economists see stocks such as Woolworths ((WOW)), QBE Insurance ((QBE)), AMP ((AMP)), CSL ((CSL)) and the five major banks as being among those who can best weather the storm.

JP Morgan economists have offered that industrial relations policy is the biggest risk. If a dismantling of Work Choices pushes wage growth above 4% in the current tight labour market, this would “severely impact” all sectors, JPM believes. The hardest hit would be the big employers such as engineering services, construction and transport, while retail would also suffer to a lesser extent.

Turning to environmental issues. Labor will clearly be tougher on Big Industry than the Coalition was ever prepared to be. This might have some big polluters shaking in their boots a bit, but the reality is most corporations have long ago started assuming tighter emission controls will be imposed some day and have thus began to adapt accordingly. Rudd will be a lot less lenient on industry concessions, and tougher on emission targets. The first thing he is going to do is ratify the Kyoto Protocol straight away, and his first international duty will be attending the new session of negotiations in Bali where a “Bali Protocol” will no doubt be even more rigorous.

If you’re a coal burner you might now feel very afraid, but you’ve had all year to prepare for a Labor victory. The reality is that a system of carbon trading will come about much more expediently under Labor, given all the states have prepared a cooperative framework that simply needs federal endorsement. What this means is that as fast as emission reductions are imposed, the opportunity of carbon offset will become available. If the big polluters are well prepared they will actually find this to their benefit. In the meantime, carbon offsetters such as alternative energy companies and carbon sink providers will receive a boost. From a share price perspective, nevertheless, valuations already reflect a new carbon regime.

When it comes to superannuation, the new Rudd government is somewhat between a rock and a hard place. The Keating Labor government introduced compulsory super in 1992, and the intention was always to incrementally increase the contribution rate from 9% of payroll to 12% and ultimately 15% to offset the cost of Australia’s ageing population. The Howard Coalition government maintained compulsory super, but has not increased the contribution. If Rudd were to do so now, it would be a fiscally responsible move in the face of the inevitable rising cost an ageing population will impose. However, it might also be political suicide to take more money out of Australian pay packets at a time of rising mortgage, energy and food costs.

Were the Rudd government to take the risk anyway, then JP Morgan identifies obvious winners in AMP, AXA ((AXA)), IOOF Holdings ((IFL)) and Challenger Group ((CGF)).

Infrastructure is one area where the Rudd government has made spending promises. Road and rail plans will be a boost for the likes of Leighton Holdings ((LEI)), Downer EDI ((DOW)), Boral ((BLD)) and Adelaide Brighton ((ABC)), JP Morgan suggests, while Leighton and United Group ((UGL)) should benefit from Rudd’s water plans in the Murray-Darling basin.

Telecommunications is another area where a Rudd government will likely have an impact, given its intention to move rapidly towards a fast broadband network. However, as to whether this would benefit Telstra ((TLS)), Optus ((SGT)) or anyone else specifically is still very much uncertain until a definitive decision is made.

JP Morgan suggests a Rudd government may be a lot tougher on competition policy, imposing its influence in the fields of bank fees, supermarket and petrol pricing. If so, this would impact on the banks, Woolworths and Caltex ((CTX)).

Other potential winners may be Ramsay Healthcare ((RHC)), if Rudd moves to take over public hospitals; ABC Learning ((ABC)) due to initiatives in education rebates and initiatives in skills training; and maybe even Fortescue Metals ((FMG)), if Rudd does play the socialist hand and force competitive access to privately owned rail links.

These are all longer term considerations in the new Rudd regime. In the short term, how is the market going to respond to Saturday’s victory? Well that answer’s clear – the market is already up 100 points. Is it hooray for Rudd?

Well there may be some element of a decisive victory is positive compared to a hung decision, but the reality is business as usual. The Dow was up 181 points on Friday, and Rio Tinto ((RIO)) is up over 7% on Chinese takeover rumours. If the Dow had been down, and no Rio rumours existed, it could have been a very different Monday story.

Macquarie quant analysts have had a look at the historic reaction to elections and specifically changes of government. Their conclusion is that a change of government, no matter into which flavour, is usually met with a positive reaction in the following week. Indeed, the market has always been higher within six weeks of the change (since 1960 anyway), with the exception of 1996. And that was Howard getting in. As to wether there is any specific correlation is debatable, particularly in this day and age, given markets are not as influenced domestically as they are globally.

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