Another Week, Another Political Mess.

2016 Federal election – Potential hung parliament
Another week, another shock political result. With so much yet to be decided, we make some quick inferences and offer some perspective on potential market impacts. We take the political press ‘as read’ and infer that a hung parliament is the base case outcome.

Messy policy implications
A hung parliament or even a razor thin majority may effectively deliver a government without a mandate. i.e. these scenarios cast serious doubt over the passage of key proposed legislation around superannuation, company tax, industrial relations and even this year’s federal budget. Key spending cuts (e.g. healthcare) may be forced off the table. We will consider these in more detail separately.

Potentially messy economic implications
A more difficult legislative environment may delay the process of reform which may impede future economic flexibility and arguably growth. Australia’s fiscal position is unlikely to improve under a minority government which puts a cloud over its AAA credit rating. We’ll be watching indicators around business confidence and investment and their potential impact on employment and growth.

Short-term market implications
Saturday’s events re-enforce our view that the RBA will move to again cut rates in August, although this itself may be taken positively by the market.

Political instability ratchets up, but this is a familiar story
Political instability is clearly concerning and we know that markets discount uncertainty. However we pose these questions: 1) are perceptions of Australian politics going to change that much in the context of 5 Prime Ministers in 8 years?; and 2) is a hung parliament going to concern all-important marginal offshore investors more than the Brexit inspired political crisis in the UK/Europe and the unknowns around Trump versus Clinton in the US? We suspect not.

Of deeper concern in the medium term is the rise of populist politics globally, as seen in the rise of the European radical right, the shock Brexit result and the US Republican nominee. In President Trump? (29/3/16), Michael Knox explains how populism can be very successful, and well supported by markets in the short term (e.g. increasing budget deficits), yet it is short term success purchased at the cost of potentially high long term damage.

Economic realities will ultimately drive the market
This result shares similarities with the events post the September 2010 Federal election. Australian shares rallied strongly under the Gillard minority government (2010-13), with Telcos and Healthcare stocks surging 65-75% and Banks 40%, due primarily to a fall in the RBA cash rate from 4.5% to 2.5% (See Chart below). Our point here being that economic drivers far outweighed the political during this period of instability, but we note that valuations are elevated this time around.

What we expect from the market
We expect volatility to spike, particularly as markets have rallied close to their pre-Brexit levels. Banks are likely to be most susceptible. Chart 2 below shows that markets very quickly rebounded from the equivalent “hung parliament” inspired volatility in late 2010 however market valuations are far fuller this time around.

Conclusions / Implications to Equity Strategy
The lack of a political majority and clear mandate for government is clearly frustrating for markets. At this stage we retain our cautious Investment Strategy but again stand ready to accumulate quality names which may be oversold in any market over-reaction, similar to last week’s Brexit shock.

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Thanks for some of this data from Di Colledge and the broking team at Morgans.

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