Where’s the growth?
Continued slowing of China’s long term building boom is reducing demand for our mining output, resulting in even lower Australian tax revenues. So Australia’s growth outlook is fragile but probably gradually up from 2.8 to 3.2% in 2016 with lower mining receipts offset by our weaker currency and low interest rates.
We are in a difficult cyclical phase, where tighter Federal Budget spending would be unhelpful. Replacing doubt and uncertainty with improved confidence is needed as the political risk to our economy is now high. It’s a juggle between implementing unpopular policy for better Budget settings while reforming productivity, capital and labour markets. China still has a long term need for our resources to build infrastructure but its rate of construction has slowed. Apart from current low ore prices, the long term demand for our resources is fine – but slower (the coal outlook is questionable in the context of climate change). Meanwhile a lower A$ helps local tourism and exporters.
The IMF forecasts 3.8% global growth next year. Expected continuing US recovery means its growth should rise from 2.4 to 3.1%. In Europe, growth should move from 0.9 to 1.5% in 2016 with considerable variability between countries.
Despite ageing populations and a need for improved productivity and investment, the growth outlook is brighter for advanced economies than for developing nations. This is mostly due to cheaper oil encouraging production and consumer spending in rich nations. Emerging market growth may fall slightly due to falling prices for key exports like oil (Russia), drought (Brazil) and geopolitical risk (Russia). We still consider an overweight position to emerging economies (particularly Asia) will be beneficial in the medium-term.
What about oil?
US shale oil fracking technology (increasing supply) and slower growth in China (lower demand) have pushed oil prices down since mid 2014. Further, improving US-Iran harmony may result in sanctions being lifted after 35 years – this would dramatically boost supply, pushing global oil prices much lower. Against this, the Sunni-Shi’ite conflict (Saudi Arabia vs Iran) could disrupt supply, pushing oil prices up. It’s now around $US50/barrel but could be anywhere between US$10-100 with the likely long term price deemed to be about US$75.
Globally, long-term bond yields are in a falling trend – EU rates almost zero, Japanese long bonds 0.35%. Such low rates are pushing global cash towards relatively higher US rates, which in turn is forcing those rates further down. US and Australian 10 year bonds are now below the GFC low points (now ~2%). Short term cash rates are watching for the US Fed to lift rates but the Fed is cautious, partly influenced by its strengthening US$.
Here, concern about low inflation is pushing our Reserve Bank of Australia (RBA) towards even lower cash rates (perhaps 2% in May) for a new historical low. But it gives the RBA less room for future action. Prospective returns from bonds and hybrids are now around 3% pa, so stock prices contiue to be pushed higher in the search for income.
Low rates may be here for years and only gradually rising, implying a prolonged hunt for yield – unless some disruptive circumstance arises. Meanwhile, limited corporate debt leverage may eventually reveal companies’ inability to satisfy the growing demand for yield.
So, it’s a perplexing outlook. Investors may take heart from the slightly better growth potential in the developed world, which may justify stock prices. But neutral real interest rate settings may now be lower than in years past – if so, smaller yield recovery lies ahead.
We’re probably headed for higher taxes because the long-term budget outlook needs it – but it will be important how voters perceive this. So, what’s being considered? Changing the GST is unpopular though it is well below the global average.
The flat rate of tax on superannuation contributions and earnings is being reviewed and some reports mention limits on lump sum withdrawals as well as tax on larger pension fund balances. So, this may all prove controversial where consultation becomes crucial.
The influence of lighter capital gains tax treatment on investor decisions to borrow heavily against residential property (negative gearing) is considered a possible source of distortion. So solving any perceived negatively geared housing problems may involve changing capital gains tax as well as deductibility rules for investment property losses, rather than removing negative gearing itself.