The gov’ment done it

An investment note by Southern Cross looks at the effect of Australia’s political leadership on the stock market, which is a subject not often addressed, at least by analysts. Privately, many say that the Resources Super Profits Tax has scared off foreign investors for a very long time because it made Australia look “socialist”. If they are scared, then they are dealing with their fears well. About two fifths of the local market is foreign investors. Not to mention the forthcoming capex boom which is, in some sigificant part, funded by foreign debt. Doesn’t seem to be worrying them all that much. But leaving aside such small details, it is an interesting subject. How does political leadership affect valuations? The Southern Cross report is very confident of the right wing credentials of foreigners. It is quite a rant against Labor and the Greens.

Despite near-record commodity prices, multi-decade balance of trade highs, full employment, strong economic growth, and a very strong sovereign debt position relative to the OECD peer group, Australia’s ASX200 continues to underperform the majority of global equity markets. Why?  As I mentioned last week, I believe the primary reason remains political uncertainty.

Sadly, it has become very clear to me, that political and regulatory uncertainty is still haunting equity investors, but particularly foreign investors. Uncertainty leads to a lower equity risk premium and therefore lower P/E’s. Similarly, uncertainty leads to weak consumer confidence and you can see that manifesting in the increasingly sloppy discretionary retail and residential property markets right now. Australian households have lost confidence because they have no clear federal leadership.

It seems to me that to describe this balderdash would be too kind. There is no sovereign risk in the Australian share market itself. Transactions will be efficiently settled, and there is a strong legal framework. So it can only be that government policy will hit profits, which may happen with a carbon tax, but is not likely to happen with any significant resources tax (the proposals look to me more like a way for the  mining majors to screw their smaller competitors). It might also be pointed out that the low valuations apply to Australia’s global mining giants and that has very little to do with Australian domestic politics (which, in any case, the miners seem to be able to influence at will). They are global companies, dual listed and transact in $US.

As for consumers, there may be some truth to it, insofar as Federal poicy making has turned away from an endosement of profligate private sector debt accumualtion of the last decade or so. But that hardly stikes me as weak leadership.

Nevertheless, Southern Cross is convinced that foreigners vote for the Coalition:

It is easy to forget the unprecedented regulatory uncertainty for the telco, materials, healthcare, energy and bank sectors under the previous Rudd government. That is not to mention the complete incompetence and fiscal waste in the implementation of the solar insulation, the education revolution, the cash for clunkers programs, the unnecessary cash handouts (which went through the pokies) etc, etc, etc. Consequently, Australian taxpayers now await the highly unlikely prospect of a balanced budget in FY 12/13 before the government can attempt to repay a forecast $150b public debt which has risen from zero at the end of the Howard government’s term. Seriously, if this level of management incompetence had occurred in a public company, the directors would have been sacked or fined. Yet, this is what happens when you let career public servants who have the sole aim of being re-elected loose on a pristine national balance sheet.”

A complete dismissal of the handling of the GFC, in which Australia, obviously by complete accident, was about the only developed economy that did not experience a recession (although given the housing bubble that might be only a delayed effect). If Australia’s governance is so bad, one wonders why the foreign exchange dealers are pushing the $A up so high. Sure, the $A is a proxy China play, but it is also a vote on sovereign risk.

And how bad was the Australian leadership when compared with the government debacles in the North Atlantic? Conversely, if we do accept that the local political leadership is weak, doesn’t that mean that it will not interfere very effectively? And in any case, since when did investors like to vote on the industrial policy of governments; don’t they prefer governments to be hands off? I thought that in the laissez-faire playbook industrial policy is necessarily counter productive and to be avoided at all costs.

Looks like I am wrong on that last point. Government “agenda” is crucial for foreign investors:

In the meantime, it is clear that the political uncertainty created by the Rudd government, which will surely be recognized as our worst ever, has emerged in another form. The new political uncertainty is a Labor /Green coalition which remains dependent on the support of the self-serving interests of minorities which have brought new policy initiatives and regulatory reform to a grinding halt. A recent poll in the Australian newspaper highlighted the extreme level of frustration of the country’s top CEOs at the current policy vacuum in Canberra. Clearly, Australia’s corporate leaders are desperate for a reform agenda, or at least some policy transparency, on the chronic skills shortage, the mobility of labour, crucial infrastructure spending, tax reform, State/Fed red tape  or a definitive policy on carbon pricing, just to name a few vital issues. However, it appears a divided Labor lacks the political will, or the ability, to set a strong policy agenda for the future.

This seems suspiciously like the kind of “government should be hands off except when I need something” argument that corporate leaders routinely come out with. It also resembles the “if only countries were run as efficiently as corporations” argument favoured by business leaders (corporations being a  beacon of effective internal democracy, of course).

The truth is that foreign institutional investors make their allocations based on global geo-economic trends, the obvious one being the rise of China. At best, what the Australian government does is pretty marginal: how many American fund managers even know where Australia is on the map? It is true that there is a heavy right wing bias in investment markets, which does not go down well with supposedly left wing governments (both political parties are centrist). But any ideological issues are quickly put aside when making money is involved.

I think we need to look elsewhere to explain the underperformance of the ASX, such as the effect of the high $A, resulting from overconfidence in foreign investors.

Southern Cross

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Comments

  1. It is a pretty accurate refection of the general thinking amongst brokers and the institutions I would say.

  2. What…the stock market hasn’t performed well because only 70% of it is owned by foreign entities?
    Easy to fix …change it to 100% :-).

  3. “I think we need to look elsewhere to explain the underperformance of the ASX, such as the effect of the high $A, resulting from overconfidence in foreign investors.”

    I’d have thought with your decent grasp of the nature of ‘money’ you’d have thought to look at corporate credit spreads & compared them to the ‘performance’ of the stockmarket.

    This so called high $A has nothing to do with it. The truth is the $A has merely been relatively stable in recent months, how can this be bad for the country?

  4. “A complete dismissal of the handling of the GFC, in which Australia, obviously by complete accident, was about the only developed economy that did not experience a recession (although given the housing bubble that might be only a delayed effect). If Australia’s governance is so bad, one wonders why the foreign exchange dealers are pushing the $A up so high. Sure, the $A is a proxy China play, but it is also a vote on sovereign risk.”

    All the Governmentt stimulus would have been impossible without the extra Foreign borrowings and the sale of assets.Aus had a ‘capital import’ (damned modern b****y euphemisms) of $100B in the 12 months following the onset of the GFC.
    This capital import was only possible because we have about the highest resources per head of population in the world, combined with our willingness to sell them off to fund current consumption.
    So yes it IS more or less by accident that we did not suffer too much during the GFC and it was at the expense of more debt and more asset sales of our industries, in-ground mining resources and Agricultural land.

  5. JMD, I quite agree about the credit spreads. In theory, a rising $A should be a disincentive to foreign investors, and it was while the $A was rising, according to Deutsche Bank data. But once it stabilises the problem eases, as you suggest. Ascribing valuation trends to any single cause is a bit foolish in any case. Matters are always more complex. The feedback I hear from CEOs and CFOs (in mining at least) is that equity is expensive because we are still in a commodities boom. Hence the lack of acquisitions. They also say they could get debt very easily but they don’t want it because they don’t like the extra risk. We still live in cautious times.

    • Actually SoN, I really meant that saying the AUD is strong when you are measuring it against the USD is spurious. The USD is the obligation of the US government, not a standard of measure, despite what the politicians & financial types might say. Gold is the standard of measure of value, or at least the best we humans have and the gold price in AUD has been relatively stable for a while now.

      Also, I don’t agree that a rising $A (against the USD) should be a disincentive to foreign investors. I’d have thought a more stable currency would be just what investors want. Besides, the ASX rose more or less in tandem with the AUD/USD cross from 2003 to 2008, so there’s no correlation there. The correlation I’ve found is with corporate credit spreads, which is logical really since the stockmarket could well be considered a large collection of the junkiest of junk bonds. Corporate credit spreads have been fairly stable, though much wider than pre ’08, since about Sept ’09 which just happens to be when the ASX started going sideways. Why the stability? Graph the open market operations of the RBA and overlay it with corporate credit spreads, you may be surprised with the result!

      All this data is available on the RBA’s website, though you may need a trip to the Australian National Library, as I did, to get data back to 2001 from the RBA bulletin.

  6. Go to
    http://www.rba.gov.au/statistics/tables/index.html

    there you will find A3-Open market operations, F3-Capital market yields & spreads-Non government instruments & F8-International share price indices, as well as exchange rates & other interesting data.

    The only problem with F3 & F8 is that the data is from Bloomberg & the RBA will not republish older data. Is is available in the RBA Bulletin hardcopies though. I spent a few hours at the ANL in Canberra hand copying the data back to 2001. Other state or university libraries may have the hardcopy editions of the Bulletin.