For investors who thought the political arena couldn’t get any more depressing, the uncertain result of Saturday’s Australian election was a further step down and an unmitigated disaster
On Friday, the markets were pricing in a Coalition victory, with potentially a Senate that might be able to pass most of its policies.
As I sat bleary eyed watching the results come in, I became even more disillusioned with domestic and global electorates to produce any kind of government that has a mandate to implement serious policies and make tough, long term decisions. Which politician, which Prime Minister is going to stand up and make the difficult choices? We seem to be stuck in a sort of tedious groundhog day; are voters really happy with the outcomes that they are choosing?
Whatever your political persuasion, the fact that Australia is likely to produce such a hamstrung government is not conducive to solving Australia’s macro economic problems of budget deficits, growing government debt and slow growth. Unfortunately it looks like we have got more of the same and we have nobody else to blame but our collective self (yes, I am a naturalised citizen and voted).
After losing, at least Roy Hodgson or Michael Cheika have the option of either resigning or tweaking a few players to come up with a winning strategy. What can we do? Sit here and watch the country stumble through another three years with minority players getting far too much political attention and pork barrelling, with the outcome that nothing gets done. Is this what it has come to?
What does it mean for investors?
After Brexit, investor anxiety increased, as it was the fear of the unknown. In Australia, this election result is less about the fear of the unknown and more about severe disenchantment that critical long term decisions will be put off into perpetuity.
Unfortunately both have the same impact; uncertainty leads to a further reduction in Keynes’ so called ‘animal spirits’. If you are a business or individual, this election result fills you with nervousness and apprehension and not confidence. The new political environment is not going to be conducive for big business or consumers to make big spending commitments either on plant, equipment and other capital expenditure or at the shops.
Given we are at an economic tipping point – is growth sufficient to continue on an escape trajectory? The probable outcome is for economic growth projections to be tempered and company profit forecasts to be slashed much the same as it has been the case in the UK.
Given lower for longer economic growth, it is likely that the Federal (and State) finances would deteriorate. It is entirely plausible that the rating agencies may take a swing at Australia’s AAA/Aaa/AAA rating; initially, this is more likely to be a review for possible downgrade or a negative outlook rather than an outright cut to the nation’s credit rating.
With these scenarios on the cloudy horizon of disappointment valley, the lower for longer mantra is chanted as powerfully as ever. The Australian dollar is likely to lose a little of its recent shine but not too much, the pressure on the RBA to cut interest rates will intensify and government bond yields are likely to remain depressed and even fall further.
But what about the potential downgrade to Australia’s sovereign rating?
Well, as we've seen when the US lost its AAA rating in August 2011 and more recently when the UK was downgraded by two notches because of Brexit, on both occasions government bond yields actually fell. So it is not inconceivable that if Australia were to get downgraded, you could still see government bond yields stabilise at current levels, or even fall further.
At time of high investor anxiety, we've seen time and time again that it is almost completely irrelevant what the absolute level of yields is on safe haven assets. As a fixed income portfolio manager, what bigger crisis do you have than your sovereign getting downgraded?
It is less the credit agency's cut to the rating that is important but more the underlying reasons for the downgrade – be it issues with the budget and getting the deficit down or lower growth prospects and higher unemployment – that will drive investors to choose safe haven assets over risk assets. And that will likely mean bond yields are going to trend lower and be there for longer.