Federal election: impact on investment markets

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The federal election on May 18 could affect your clients. Here’s how.

News outlets routinely make a big deal out of financial market reaction to election results, as if the reaction were a key indicator of investor sentiment on party policy.

However Craig James, Chief Economist of CommSec, says the short-term outcome of Australian federal elections for financial markets has actually been remarkably consistent over time.

CommSec’s review of elections and financial markets1 shows that, based on past results, the Australian share market tends to drop in the weeks before an election, and rise in the weeks after. That result has held since the two Gough Whitlam-led Labor wins in the early 1970s, and has applied equally to Labor and Coalition wins.

When it comes to the Australian dollar, the short-term results are slightly more mixed, says James. His analysis finds that the currency’s short-term rise was positive after the last eight federal elections, but only by 0.3 per cent in 2016 and by 0.4 per cent in 2007.*

The reason for the pre-poll drops and post-poll rises is due to political uncertainty.

“Removal of uncertainty is important for investors, businesses and consumers” says James in his review of elections and financial markets. “The best outcome on May 18 will be a clear election result. There are good reasons to expect a stronger Australian economy once election uncertainty is resolved.”

Long-term impacts

Furthermore, James says in the longer term it’s important to note that both parties have emphasised their commitment to fiscal stimulus, meaning each side has pledged to cut taxes and implement spending measures, including large-scale public transport-related infrastructure projects. James estimates that in the current environment fiscal stimulus will provide more effective support for the economy than the small incremental cuts to the Reserve Bank’s record low official cash rate.

While it’s true that tax cuts and spending promises may reduce the budget surplus, or return it to deficit for a few years, James argues that a temporary return to deficit would not be a negative for an economy that has lost some growth momentum, but is still generating solid job growth.

James noted that the bond market is a global market, and therefore less sensitive to the results of an Australian election than other asset classes. He said the outlook is for low inflation, at least in developed economies. Low growth and low inflation tend to put downwards pressure on bond yields. And foreign investors remain attracted to Aussie government bonds due to Australia’s AAA credit rating and superior fiscal position.

From the point of view of investors in Australia, there have been two big talking points of the election. First, how Labor’s policy to remove cash refunds for franking credits from the start of the 2020 financial year would affect the share market. And second, whether the removal of negative gearing on existing properties, to apply from January 1, 2020, would put further downward pressure on residential real estate prices.

Labor’s franking credit and negative gearing policies

“The franking credit issue largely affects a subset of investors” stresses James. “People will continue to invest in shares. Will they go for different kinds of stocks? Will companies alter the way they deliver returns? It’s too early to say. But what we do know is that it’s not a broad sector of the market, and there may be ways that restructuring investments can minimise the impact.”

Labor’s negative gearing policy affects a broader population, but James estimates that two elements will blunt the impact.

“First, if it was being introduced five years ago it might have had more of an impact. Nowadays there’s a higher proportion of positively geared property because inflation is lower, therefore interest rates are lower. The increase in the tax-free threshold means that tax rates are also marginally lower, particularly given the low wage growth over the last few years.

“Second, I think the timing of the introduction is important. If the change were scheduled to happen immediately, that could be disruptive, but Labor intends that the changes will apply from January 1, 2020.

“If you’re introducing a measure that has the potential to keep investors on the sidelines at a period of weak markets, that will have more impact than introducing it when conditions have stabilised. Over the next few months we see residential property markets flattening. As always, the market is driven by supply and demand, but encouragingly the populations in NSW and Victoria are rising.

“That being said, on both negative gearing and franking credits, if Labor is elected the final scope of any changes would be subject to whatever negotiations are necessary to pass legislation through the senate.”

US-China trade talks

For James, the most important issue affecting investor sentiment is not the election, but the US-China trade talks.

“The successful resolution to the US-China trade talks is the single most important event to look out for” he says.

“At present, having the two largest economies imposing tariffs on each other has the potential to slow global growth, altering the current ‘neutral’ interest rate policy settings of both the Reserve Bank of Australia and US Federal Reserve.”

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Important: This article has been prepared without taking account of the objectives, financial or taxation situation or needs of any particular individual. Before acting on the information, you should consider its appropriateness to your circumstances and if necessary, seek appropriate professional advice. Any information used in this article is for illustrative purposes only. *Past performance is no guarantee of future performance.