Cash refunds on franking credits live on post- the election, and dividend yields also remain compelling relative to term deposits, particularly with rate cuts on the horizon. High-yielding stocks will therefore be bid as the franking credit system is no longer in the firing line, keeping demand for high-yielding, fully franked stocks intact.
Banks and financial services companies rallied as the Morrison government is perceived to be more business-friendly. The major banks, being in the high-yield bucket, also have a significant weighting in retiree portfolios and are now safe from any pressure that could have materialised from changes to franking credits.
The gains today were likely magnified by a short squeeze on traders expecting a Labor win, and investors rebalancing heavy underweights in the banking sector. On that basis, the rally could be short-lived as the banks still face continued NIM pressure, headwinds from decelerating housing credit growth and a sagging property market, increasing bad debt levels, and ongoing remediation and regulatory expenses. All of these factors make the outlook for bank earnings challenging. These themes were evident in the recent interim reports, where it was made clear that the banks face significant difficulty in growing revenues.
Weak mortgage growth will remain via increased scrutiny on the capacity to service debt and heightened expense verification by the banks; a Morrison government won’t stop the banks from recalibrating their lending standards. To summarise, the earnings outlook remains under pressure despite the election result as not much has materially changed and revenue growth will remain anaemic but there are fewer risks on the horizon with a more “pro-business” government and no changes to negative gearing.
Property and housing-related stocks will find support as there will be no changes to negative gearing, but this could be short-lived as the housing market is still soft and the outlook remains challenged. The changes to negative gearing, however, would have added further pressure to an already weak market so the removal of this negative may put a floor on these stocks for the time being. There may be a boost to confidence in the housing market from the fact that Labor’s proposed changes to negative gearing won’t go ahead, but fundamentals are still weak, credit growth remains under pressure and new supply is yet to come online – particularly in Sydney and Melbourne.
The pace of declines in the housing market may have moderated but the declines are also more broad-based on a national basis. The credit-driven adjustment is still underway, pointing to continued weakness. This makes it unlikely that the housing market will bottom in the near term, although the outlook is undoubtedly less negative.
The AUD found relief from the elimination of the threat of Labor’s less business-friendly policies and improved economic sentiment with a Morrison victory. Traders are cheering as they have one less uncertainty to deal with – a Labor government with a progressive redistributive agenda – at a time when the economy is losing momentum and the country is caught in the crossfires of the US/China trade war.
The bounce may fizzle as AUD remains under attack with rate cuts on the horizon and the escalating trade tensions; with these worries still looming large, any relief rally may be cut short. The Reserve Bank of Australia minutes are out tomorrow and Governor Lowe’s speech could erase any gains today. Given the current lack of clarity from an RBA that has left market participants second-guessing whether their reaction function has shifted, Tuesday will be an important day for RBA watchers.
Governor Lowe’s speech titled ‘The Economic Outlook and Monetary Policy’ could be vital in resolving the current confusion given Lowe has previously used speeches to provide monetary policy guidance (see: February). The minutes of last week’s monetary policy meeting will also be released on the same day, so the current ambiguity could be rectified in the minutes as well.
Despite the return to “business as usual” the Morrison government still have to contend with a languishing economy, stagnant wage growth and a slumping housing market. Once the sugar hit of the election fades, reality should soon set in and investors will turn their attention elsewhere. The bigger impact for company profits is the fragile state of the economy, global risks (elevated trade tensions and the Chinese slowdown), monetary policy and the sluggish housing market, which will be more impactful on economic growth and profit growth over the long term.