Government Intervention: Right then Left

market analysis

Man reading the newspaper article on Government Intervention

By

Paul Ashworth, Managing Partner
David Clark, Director
Campbell Cooke, Senior Analyst


Posted 25 January 19

At the end of a bull market, when the gains have been disproportionately shared between ‘winners’ and ‘losers’, it is not unusual for governments to seek to interfere in an otherwise effectively functioning market.

Rising inequality in developed markets – although reduced inequality worldwide due to increasing standards in emerging markets – gives rise to voter discontent and populist policies – first the right and then the left.

Intervention can occur in several ways – trade tariffs, tax changes (negative gearing, franking credits), royal commissions, state ownership of private assets (Corbyn) – but all bring uncertainty and risk for investors.

Globally we see a retreat from the free(r) market values that have underpinned the globalisation process. The world believed that once China secured more wealth, the Chinese would embrace Western values. This was mistaken, and we view the recent trade friction between the US and China as a symptom of a recalibration in western policy to China’s expanding political and military goals.

Change in Gini Coefficient between 1976-79 to 2006-08.

The Gini Coefficient is a gauge of economic inequality, measuring income distribution or, less commonly, wealth distribution among a population. A Gini coefficient of zero expresses perfect equality, where all values are the same (for example, where everyone has the same income).

Change in Income Inequality

Diagram showing Change in Income Inequality

Escalating Trade Wars

In the short-term everyone loses from a trade war, just to differing degrees. Manufacturers sell fewer goods and consumers pay more for the goods that they can buy.

The United States is gambling that the impact to the Chinese economy is greater than the impact to US consumers – this is probably true – giving them an upper hand in redefining the trade paradigm for the next 15-20 years.

An escalation of the trade dispute will further anchor declining global growth, place downward pressure on oil prices and upwards pressure on core US inflation – which could, in turn, mean faster tightening by the Fed. These are all significant risks, however, the major impact has been to investor confidence, and this drove the stock market falls in the last quarter of 2018. Global markets have been on high alert for the ‘trigger’ that will bring this long bull market to an abrupt end – this trade dispute has, in turn, triggered a large withdrawal from risk markets.

Since the end of WWII, global trade barriers have followed a steady downward trend. By the year 2000, US effective tariffs fell to 1.5% of all imports and 4.5% of dutiable imports. Thanks to the North American Free Trade Agreement and other free-trade agreements as of August 2018, 70% of all imports now enter the US duty-free.

US Effective Tariff Rates

Diagram showing US Effective Tariff Rates

Federal Election Outcome

In Australia, we are due for a federal election by May this year. For investors, the election is the most significant in recent memory due to the large differences in economic policy between the two major parties.

A Shorten Government is expected to pursue a higher taxing, higher spending platform; with significant money for health and education. Conversely, the Coalition has dangled tax cuts; individual and corporate, and a return to budget surpluses to win over voters.

A Labor Government poses a greater risk for investors as the funding for these investments is proposed to come from the removal of franking credit refunds, a reduction in the capital gains tax discount exemption and changes to negative gearing rules. Further to this, it raises the prospect of a stronger, more militant and pervasive union movement, which could heighten stock-specific risk in union dominant industries.

Economic and Investment Strategy

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