The Budget And The Stock Market

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– The Budget was underwhelming
– While very contractionary, new spending balanced cuts
– No real relief for the RBA
– Little impact on stocks

By Greg Peel

The Treasurer announced last night that the Budget would be in deficit of $22.6bn in FY12 and in a surplus of $3.5bn in FY13.

The amount of FY12 deficit is larger and the amount of FY13 surplus is smaller than the previous budget suggested, impacted by weather, the strong Aussie, and a two-speed economy providing fewer tax revenues. Even the booming mining industry is madly spending on projects, thus also reducing potential tax receipts. There are two points to note here.

The first is that there are a lot of elements the government has little control over from May to May, and that's even before we get to weather. From a political perspective the government has been hellbent on being able to “announce” a surplus, albeit one depending on an enormous number of variables, but the FY13 surplus is so small that there is a distinct danger it may not be achieved. Secondly, were the result to ultimately come in at, say, a $3.5bn deficit rather than a $3.5bn surplus, it would imply a very negligible variation but boy wouldn't the Opposition jump all over it, whoever might be in Opposition at the time?

Incremental changes in commodity prices or the currency from forecasts in the meantime, for example, would completely alter the result.

If the Australian economy is booming then a return to surplus is very important, notes Macquarie. It alleviates the inflationary pressure of borrowing-to-spend in the public sector when the private sector (ie resources) is already applying enough inflationary pressure. But if the economy is weak as it is now, notes Macquarie, then the goal of a surplus is still important. Borrowing can become a downward spiral.

Macquarie notes, “The impact of fiscal policy on the economy, however, does not depend on whether there is a surplus or a deficit, but on the change in the Budget balance. And when [this] Budget is viewed through this frame, it points to the most contractionary Budget in 40 years.”

The main story to come out of this Budget is the “huge” reduction in the deficit, from over $50bn now to $22bn and then surplus, and the negative impact it will have on economic growth in FY12, suggests Macquarie. Both households and businesses will see lower rather than higher incomes through tax and welfare changes, and household spending will thus suffer. As Goldman Sachs puts it, “Sharing the benefit of the boom will likely feel more like sharing the pain of adhering to a 2012-13 fiscal surplus target”.

Goldmans notes that should the government reach its FY12 Budget objective, it suggests a fiscal contraction of a “staggering” 2.1% of GDP. The biggest contraction previously was 1.4% in FY00.

Yet this was not by any means a Budget of “deep cuts”. It seems the tradition these days is to talk tough beforehand and then elicit a more popular response on the night of “phew”. JP Morgan sums up economist views by noting, “new savings announced [last night] are balanced neatly by new spending initiatives”.

The result is the RBA will not be getting much help from the fiscal side while it struggles with tough monetary policy decisions. UBS suggests initiatives to improve productivity are “commendable”, and Goldman Sachs suspects the RBA will acknowledge it is a contractionary Budget and welcome the labour market initiatives within. However, JP Morgan again echoes consensus in noting the Budget contains little in the way of fiscal tightening and as Citi notes, the return to surplus won't stop the RBA tightening monetary policy.

For the stock market, there was neither anything to be generally excited about nor generally concerned about. If labour market pressure can be eased through new Budget measures then Australia's capex boom becomes less inflationary, but the policy is not going to have a huge or immediate impact, JPM suggests. At least there were no more “lightening raids on corporate returns” this time. Citi believes the Budget is unlikely to greatly alter the backdrop for the stock market and Macquarie points out no change to the negative pressures on the consumer and no change to Aussie dollar pressure. There thus remains downside risk to earnings forecasts both outside and inside the resource sector in FY12.

Deutsche Bank points out the obvious, nevertheless. There was nothing in this Budget which provided any new information on big-impact measures such as the carbon tax, mining tax or the NBN. As these are ratified over time, interim Budget changes could look a lot different to last night's offering. And one can take it another step further in suggesting that whichever party gets to deliver the next Budget will be determined by whether this government can push through far-reaching policy without a double dissolution being forced.

Investors in the listed healthcare sector are those most likely to be holding their breath on Budget night given the potential impact of government policy on earnings, but last night's result was not particularly influential. A quick summary would be that funding increases in radiology will benefit Primary Health Care ((PRY)) and Sonic Healthcare ((SHL)) but then more mental healthcare funding for GPs will undermine Primary. Only a small step was made towards means testing private health insurance rebates, which means a small negative for Ramsay Health Care ((RHC)) that could have been worse. Means testing nevertheless remains on the government's agenda.

The Budget forecasts suggest further falls in unemployment, further wage growth and a stabilisation of the savings rate. If accurate, this is good for the retail sector over time and thus Citi maintains its Buy ratings on David Jones ((DJS)), Myer ((MYR)) and Woolworths ((WOW)). But there was no immediate relief offered to the currently weak retail sector last night, and nor was there sufficient fiscal tightening to imply lower inflationary pressures and thus a let-up from the RBA and the Aussie.

In transport, RBS suggests spending initiatives for roads may present Transurban ((TCL)) with opportunities, and the Pacific Highway duplication should add to an already solid pipeline of work for contractors and material suppliers. But RBS also notes that as the big mining and energy projects ramp up, government infrastructure spending is becoming a lesser and lesser portion of overall engineering and construction spend. To make much of a difference there would have had to have been an “extraordinary” change in Budget policy, RBS suggests, which there wasn't.

So mild benefits may accrue to Leighton Holdings ((LEI)), Lend Lease ((LLC)) and Downer EDI ((DOW)), but don't sell the farm. Similarly RBS really sees little benefit, if any, for materials producers.

For the rest of us, life goes on as normal.
 

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