Summary of key points

  • There has been some sound and fury in the financial markets but it has signified nothing much.

  • The Trump administration was rolled by its own party, failing to get its healthcare change through Congress. Equity markets wobbled at the thought that this could also happen to the cherished prospect of tax cuts. We think that self interest can be relied upon to secure the tax cuts, which by some credible estimates may lift earnings per share by an average of 17% – a level not yet factored in to prices.

  • Meanwhile Chairman Janet Yellen at the Fed announced the long anticipated 0.25% p.a. lift in short-term rates. More importantly the Fed Open Market Committee is now signalling three more such rate rises. This sounds like a lot but would still leave the rate short of the Fed’s proclaimed neutral rate of 3% p.a. On this view, monetary policy continues to be stimulatory for the next three years.

  • In Australia the RBA left its short-term official rate unchanged at the record low of 1.5% p.a. among much hand wringing about the speed of residential property prices and its potential impact on bank profits.

  • APRA will tighten controls on bank lending but not by enough to cause either a residential property bust or a dive in bank profits.

  • In recent weeks, the banks have lifted their mortgage interest rates in response to the rise in their wholesale funding costs arising from the Fed Reserve interest rate increase. They did this because they cannot fund all of their home loan assets from Australian sourced deposits. The rises, which have been extensively criticised by politicians and ASIC, demonstrate the banks’ willingness and capacity to defend their profitability, return on equity and dividend paying capacity. The rises ranged from +0.07% p.a. to +0.25% p.a. Given the level of gearing in the banks’ balance sheets, these increases would have led to an increase in their ROE by between +0.7% p.a. and + 2.4% p.a.
  • Given the importance of the banking sector not only to the economy but also within the ASX 200 stock market index, this demonstration of market power in defence of profits and dividends is noteworthy, especially in the face of growing sentiment towards convening a Royal Commission into the banks.
  • Meanwhile the Federal Government is doing little that amounts to real policy change apart from announcing a feasibility study into Snowy Mark 2. Given the numbers in the Senate and the political skills being deployed we expect little change in the next two years.
  • The main factor to watch is the long-term bond yield. The sound and fury referred to above has caused some shift back into bonds from equities. This has pushed down the bond yield making equities slightly more attractive from a longer-term perspective.


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