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In recent months, investors have pondered the possibility of the US bumping up against the debt ceiling limits controlled by Congress. Through most of this time, the market consensus has suggested that the limit would surely be raised. Indeed, the reasoning has been clear – it will be raised because it has to be raised. However, as we sit just 6 days away from the date at which it is suggested the US will hit that debt ceiling, resolution appears far from certain. Each party is busy working on its own plan – one for the House and one for the Senate – and that combining portions of each plan has not yet been a part of the recent negotiating process.
As a result, markets have become more anxious and questions about how things will play out have become a central part of the investment discussion in recent days.
Our expectation remains that a resolution to the debt ceiling will be forthcoming over the next few days. That may mean that all the deals are formally signed after August 2, but default and major disruptions in this outcome would be averted.
Just as we saw 110bn Euros extended to Greece this week after much political wrangling in Europe. Commonsense finally prevailed and a default of Greece was averted for the greater good of the Eurozone.
This is certainly supported by movements in financial markets, which outside of Australia have been relatively benign.
We view the Australian market, now trading below 4,500 as once again extremely undervalued and would expect a resolution of this issue to see our bank heavy index rebound.
However, should you wish to discuss your particular portfolio and an appropriate course of action, please contact us.
We will follow up with a more detailed look at the Australian Share market next week.
Treasury modelling suggests that the introduction of a price on carbon will only boost consumer prices by an initial 0.7% and have a negligible impact on growth in the economy. While we largely agree with the assessment on inflation, we find its assertions that growth will be unaffected far more questionable.
At a minimum, the way in which the Government is compensating households for the carbon tax will have a substantial impact on the profile of growth, with the risk of a kick to spending in mid 2012 (when the rebates are handed out) and a fall in spending in late 2012 (when the tax kicks in). That said, the compensation to households is also highly redistributive, with 1/3 of households not being fully compensated. This increases the chances that the carbon tax will create more uncertainty for households and so affect both the strength and composition of spending.
Similarly, for businesses, there remains considerable uncertainty about how the price on carbon will affect their business in future years. It is an extremely detailed and complex tax.
It is not obvious that the current carbon plan will be sufficient to meet the Government's goal of reducing carbon emissions by 2020. For business, this means that there is a risk that carbon pricing arrangements could look much more onerous in a few years time and if that affects their business decisions today, then growth could look noticeably weaker.
The modelling undertaken by Treasury suggests that prices will rise by 0.7% in 2012-13 and by a further 0.2% in 2015. In our view, a price increase of around 1% is about right. The Carbon tax will raise about 1/3 of the revenue of the Goods and Services Tax when it was introduced, and the GST is estimated to have boosted inflation by a little less than 3%.
In our view, the impact on growth is far less clear and more controversial. The Treasury modelling implies that there is virtually no impact on growth, in effect, assuming that the compensation package to households and business is sufficient to offset the tax itself. But that is certainly not the full story.
One approach to estimating the impact on growth is simply to look at the net cost to the government of introducing the carbon tax – if it is a net drag on the budget, then it suggests the government is injecting more money into the economy and hence, that it could actually be stimulatory in the very short term.
Initial analysis on companies, sectors and our model portfolio.
I think we all agree that doing our bit for the environment is Australian, but this is yet another inefficient tax with more red tape, more government, more uncertainty = less business activity!
The carbon tax, as to be expected from this government, is tough on business, with a high (by global standards) starting fixed price and higher longer term abatement target and is very targeted (only capturing 65% of Australia’s carbon emissions).
Below are some initial comments on the likely impact across sectors and companies. Note however that it is very complex and will take some time for analysts to digest and understand the full impact. Key sectors that will be negatively impacted include: building materials, chemicals, transport, steel, mining (particularly coal) and oil & gas.
=> Initial estimates indicate that earnings per share across the broader market will decline approximately 1% in the first year.
=> Much better outcome than expected with 94% compensation. Earnings impact will be more for Bluescope (22c decline in discounted cashflow valuation) than Onesteel (approximately 16c decline in DCF). However, the Steele Industry’s transformation package lasts for 4 years. I have grave concerns for the industry longer term.
=> Not a sector that we invest in but the cost will be equivalent to around $4 per passenger, which equates to a 2% fare increase.
4) Transport Infrastrucucture
=> Asciano: the main impact is on fuel costs – estimated $20m fuel impact (+6c per litre increase), but AIO have contracts in place for full pass through.
=> Toll Holdings could have quite a large impact due to the fragmented and competitive landscape of the sector. They need to pass through the cost if possible - we're happy to avoid this sector.
6) Building Materials
=> Need to push through average price increase of 0.5% to offset the impact. Large parts of this sector are already suffering from import competition (like the steel sector and many other domestic manufacturers) but net of compensation and tax the price increase required (or margin hit) will be around 0.5%. However - that will likely increase over time as the tax cost increases.
=> Origin and AGL will likely be marginal beneficiaries.
8) Fertiliser & Explosives
=> We anticipate little impact for Orica and a 2% to 3% impact for Incitec Pivot which will be partially offset if increase taken in fertilisers.
=> Toll roads no impact. Airports less than 2% if no pass through.
=> Sectors net present valuation estimated to take a hit of up to 5% (however this varies from 0% - 30% across the sector as assistance for coal mines does not apply to growth in production after 2009). This is effectively another resource tax. Gassy mines are the worst impacted (GNM, WHC & GBG). Alumina less than 1% impact as refining & smelting are exempt. There is a hit to valuation across the sector given that long term pricing is set by the marginal cost producers and it is therefore unlikely that the Australian mining industry will be able to pass on any of the cost.
=> Better than expected outcome with a 50% offset. Marginal CSM projects will see a lower internal rate of return (IRR). Oilsearch no impact (PNG). Sanots 5% hit (Cooper basin tax) and Woodside 2.5% reduction in NPV.
=> A bit of a 2nd derivative on carbon as the tax offsets will likely have a positive impact on gaming revenue given more disposable income for the lower income earners. There has been a long history of this - last time we saw this was with the fiscal stimulus.
We will continue to work through the implications of the carbon tax and adjust portfolio’s as required. Naturally if you have any questions, do not hesitate to contact us.
The Australian Sharemarket has recently fallen significantly more than both the US and European markets, despite their much publicised public debt issues.
One explaination for this is an exodus of foreign investment due to increased regulatory uncertainty in Australia over the past two years.
I've attached an article by an Australian Equity Strategist that I greatly respect, articulating this view.
It's quite a long read, but one well worthwhile.
It also touches on the current market opportunities.
As always, should this article or current circumstances give rise to any questions, please do not hesitate to contact us:
Adam or Adrian Rowley - directors FYM Financial
p: 61 3 9629 9900
The RBA left rates unchanged again this month, thankfully.
In reading the official commentary (below) I believe that the tone was far softer and do not expect further aggressive rate increases over the balance of the year.
This should help to improve confidence and eventually spending across the eastern states.