Trumponomics and investment markets

Key points

  • So far President Trump has been positive for share markets but this year the focus is increasingly shifting to populist policies with greater risk for investors.
  • The key risks to keep an eye on in this regard relate to trade conflict and the expanding US budget deficit, although the latter is more a risk for when the US economy next turns down.
  • However, the best approach for investors in relation to Trump is to turn down the noise given the often contradictory and confusing news flow he generates.


Since Donald Trump was elected President back on November 8, 2016 we have focussed on whether we will see Trump the rabble-rousing populist or Trump the business-friendly pragmatist. Despite lots of noise – particularly via Trump’s frequent tweets – for the most part Trump the pragmatist has dominated so far. But we have clearly seen a swing to Trump the populist this year – raising risks for investors.

So far Trump has been good for markets

In the period since his election US shares are up 34%, global shares are up 28% and Australian shares are up 21%. While the strength in share markets would have occurred anyway given stronger global growth, US tax reform, fiscal stimulus and deregulation have clearly helped and contributed to the US share market’s outperformance. While US tax reform and tax cuts have received much focus, the Trump administration’s focus on deregulation is equally as significant with the US under Trump seeing the least amount of new economically significant regulation since the Reagan Administration in the early 1980s.

Source: George Washington University, WSJ, AMP Capital

In terms of tax reform and deregulation the Trump Administration has much in common with Reaganomics.

Populism starting to dominate pragmatism

This year though the balance has shifted towards a greater emphasis on populist policies – notably protectionism and criticism of China, the return to sanctions on Iran and arguably recent criticism of the Fed for raising interest rates and pushing up the US dollar. There are several reasons for this shift in emphasis: the pro-business element of Trump’s policies were mainly completed last year; it’s a mid-term election year so Trump is back in campaign mode; Trump’s approval rating has improved despite this year’s controversial policies suggesting firm support for them from his Republican party base; and the strength of the US economy has also emboldened him. In fact, it could be argued that last year was all about bolstering the US economy ahead of this year’s more controversial policies.
The main risks around President Trump centre around five key issues: the rising risk of a full-blown trade war; the expanding budget deficit; the risk of interference in the Fed; the return of sanctions on Iranian oil exports threatening wider Middle East conflict; and the risk Trump ultimately comes into trouble with the Mueller inquiry. We will now look at each of these in turn.

Rising trade war risks

This issue has been done to death but won’t go away. So far the tariff increases actually implemented amount to just 3% of total US imports. While this has been met with proportional retaliation by other countries it’s a long way from a full-blown global trade war. However, the issue is what happens next. Another $US16bn of Chinese imports will likely be hit with a 25% tariff soon and the US is readying a 10% tariff on another $US200bn. Trump is also threatening to raise tariffs on all $US550bn of Chinese imports. China is threatening to retaliate proportionally although it will have to be with other means as it only imports $US130bn from the US. Trump is also threatening to put tariffs on auto imports and looking at Uranium.

News of a deal between the US and the EU to work towards zero tariffs on industrial goods is good news in terms of heading of a full-blown trade war between the two, but negotiations have a long way to go. There was hope of a deal with China in May – with Trump initially crowing about a May 20 trade deal, but since then both China and the US have dug in with Trump tapping popular support for protectionism and anti-Chinese sentiment. So, the trade threat could get still worse before it gets better which means it risks taking the edge off economic growth. Modelling by Citigroup of a 10% tariff hike by the US, China and Europe showed a 2% hit to global GDP after a year. Of course, we are not seeing a tariff hike on all goods but the impact could still be significant if negotiations with the EU and China fail and all the tariffs being talked about are implemented.
There are a few offsetting factors. First, China is moving to provide stimulus to support growth. Second, much of Trump’s approach still looks designed to apply “maximum pressure” to reach a negotiated outcome – and so far so good in relation to Europe. And Trump knows that the costs to US workers (from soybean farmers to Harley Davidson workers) and consumers will escalate as more tariffs are imposed. So, our base case remains that some form of negotiated solution will be reached, but in relation to China this may not occur until next year.

Interference in the Fed and US dollar

Trump’s recent comments criticising Europe, China and others for helping drive the US dollar up and the Fed for raising interest rates naturally raises concerns that he will intervene in foreign exchange markets and interfere with the Fed. The comments lack economic logic – if “making America great again” means stronger US economic growth then it also means higher US interest rates and a higher US dollar – and maybe the Fed came in for a serve after Fed Chair Powell observed that “countries that have gone in a more protectionist direction have done worse”! Trump’s annoyance may have been triggered by the slide in the value of the Chinese Renminbi. While this looks to be mainly a strong $US story (as the $US is up around 7% against its low earlier this year against a range of currencies compared to an 8% gain against the Renminbi) the Chinese authorities seem quite content to let it fall for now and this will obviously offset Trump’s tariffs on Chinese goods.

Source: Bloomberg, AMP Capital

Despite all this it’s unlikely in the short term that Trump will act on his opinions on rates and the $US. US Treasury Secretary Mnuchin said the administration would “not interfere with the decisions of the Fed or move to manipulate the value of the dollar.” Trump is well known to be a high debt/low interest rate guy so it’s no surprise he is not happy with rising rates. But the Fed answers to Congress, has a mandate to keep inflation down and will do what it sees best – which with strong growth and at target inflation means returning interest rates to more normal levels. However, longer term there is a risk that Trump will weaken the institution of an independent central bank targeting low inflation and may also seek to return to a more interventionist approach regarding the US dollar, particularly if America’s trade deficit refuses to fall. Based on past experience such political intervention would risk much higher inflation which would be a big negative for investment assets as the revaluation that occurred as we moved from high inflation to low inflation would reverse. Fortunately, we are not there yet.

The expanding US budget deficit

It’s been the norm for the US budget deficit to blow out when unemployment rises (as tax revenue falls and jobless claims go up) and decline when unemployment falls. Thanks to Trump’s fiscal stimulus it’s now blowing out when unemployment is collapsing and looks to be on its way to 5% of GDP. This raises three risks. First, it may mean higher than otherwise interest rates and bond yields as the Fed may have to raise rates more than would otherwise be the case to stop the economy overheating and the Government’s competition for funds results in higher bond yields. So far there is not a lot of evidence of this with US bond yields remaining relatively low – presumably held down by low global bond yields and trade war fears – but its still a risk as US inflationary pressures rise.

Source: Bloomberg, AMP Capital

Second and more fundamentally it begs the question of debt sustainability when the next recession arrives given US public debt is already around 100% of US GDP. Finally, US fiscal stimulus by adding to the US savings-investment imbalance is adding to the US trade deficit and so is completely inconsistent with his trade policies. Even if there was a completely level playing field on world trade America will still have a trade deficit!

The return to sanctions on, and tensions with, Iran

Perhaps a big surprise this year for some has been that President Trump looks to have swapped a half decent deal with Iran for a dodgy one with North Korea. While the latter holds out the hope of (maybe) reducing the threat of a nuclear attack on the US, the return to sanctions and tensions with Iran risks higher oil prices. Since the lows of 2015 oil prices have increased by 70% reflecting increased demand and OPEC’s 2016 cutback. Global stockpiles and spare capacity have been rundown and supply from Libya and Venezuela is uncertain. Our base case is that demand growth will be more constrained from here and that a ramp up in US shale oil production will help contain oil prices around $US70-75 a barrel. The risk though is that the loss of around 800,000 barrels a day of Iranian oil exports and the renewed risk of wider conflict in the Middle East associated with Iran (eg, if Iran closes the Strait of Hormuz through which 20% of global oil supply moves in retaliation against US sanctions) results in higher prices.

The Mueller inquiry into Russian links

Our view in relation to the Mueller inquiry remains that unless Trump has done something very wrong the Republican controlled House will not move to impeach him and even if a Democrat controlled House post the mid-terms did, the Senate will not have the necessary two thirds of votes to remove him from office. However, his sensitivity over the issue, along with his comments seemingly favouring Russian President Putin’s word over US security agencies does remind a bit of Nixon in relation to Watergate. So his removal cannot be ruled out. But this would just mean VP Mike Pence would take over with basically the same economic policies (but with less tweet noise) and economic conditions are stronger than in 1974.

Trump tweet noise

The risks around Trump are real and need to be watched carefully. But Trump generates a lot of noise and much of it is contradictory and confusing – in the last week Trump tweeted “Tariffs are the greatest” only to tweet 12 hours later that “I have an idea for them. Both the US and EU drop all tariffs” – and often reflects bluster ahead of negotiations – recall his “fire, fury and frankly power” threat to North Korea. So the best approach for investors in relation to Trump is to turn down the noise.


2017-18 saw strong returns for diversified investors – but there’s a few storm clouds around

Key points

  • 2017-18 saw strong returns for diversified investors, but it was a story of two halves with strong December half returns but more volatility in the past 6 months.
  • Key lessons for investors from the last financial year include: turn down the noise around financial markets, maintain a well-diversified portfolio; be cautious of the crowd; and cash continues to provide low returns.
  • Returns are likely to slow and the volatility of the last six months is likely to continue. Global growth is good, this should underpin profit growth and there are minimal signs of economic excess that point to a peak in the global growth cycle. But rising US inflation and rates, Trump and trade war fears and the risks around China and emerging countries are the main threats.


The past financial year saw solid returns for investors but it was a story of two halves. While the December half year was strong as global share markets moved to factor in stronger global growth and profits helped by US tax cuts, the last six months have been messier and more constrained – with US inflation and interest rate worries, trade war fears, uncertainty around Italy, renewed China and emerging market worries and falling home prices in Australia. But will returns remain reasonable or is the volatility of the past six months a sign of things to come? After reviewing the returns of the last financial year, this note looks at the investment outlook for 2018-19 financial year.

A good year for diversified investors

The 2017-18 financial year saw yet again pretty solid returns for well diversified investors. Cash and bank deposits continued to provide poor returns and the combination of low yields and a back-up in some bond yields saw low returns from bonds. The latter resulted in mixed returns from yield sensitive investments, but Australian real estate investment trusts performed well helped by the RBA leaving rates on hold.

Reflecting strong gains in the December half as investors moved to factor in stronger global growth and profits assisted in the US by tax cuts global shares returned 11% in local currency terms and 15% in Australian dollar terms. Australian shares also performed well with the ASX 200 rising to a 10-year high and solid dividends resulting in a total return of 13%. Unlisted assets have continued to benefit from “search for yield” investor demand and faster growth in “rents” with unlisted property returning around 12% and unlisted infrastructure returning around 13.5%.

As a result, balanced growth superannuation returns are estimated to have returned around 9% after taxes and fees which is pretty good given inflation of 2%. For the last five years balanced growth super returns have also been around 8.5% pa.

Source: Thomson Reuters, AMP Capital
Australian residential property slowed with average capital city prices down 1.6%, with prices down in Sydney, Perth and Darwin. Average returns after costs were around zero.

Key lessons for investors from the last financial year

These include:

  • Be cautious of the crowd – Bitcoin provided a classic reminder of this with its price peaking at $US19500 just when everyone was getting interested in December only to then plunge 70% in price.
  • Turn down the noise – despite numerous predictions of disaster it turned out okay.
  • Maintain a well-diversified portfolio – while cash, bonds and some yield sensitive listed assets had a tougher time, a well-diversified portfolio performed well.
  • Cash is still not king – while cash and bank deposits provided safe steady returns, they remain very low.

Expect more constrained returns and volatility

We expect returns to slow a bit over the new financial year and just as we have seen over the last six months volatility is likely to remain high. First the positives:

  • While global growth looks to have passed its peak the growth outlook remains solid. Business conditions indicators –  such as surveys of purchasing managers (Purchasing Managers Indexes or PMIs) –  are off their highs and point to some moderation in growth, but they remain strong pointing to solid global growth overall.

Source: Bloomberg, AMP Capital
In Australia, growth is likely to remain between 2.5% and 3% with strong business investment and infrastructure helping but being offset by a housing slowdown and constrained consumer spending.

  • Second, solid economic growth should continue to underpin solid profit growth from around 7% in Australia to above 10% globally.
  • Third, while we are now further through the global economic cycle there is still little sign of the sort of excess that normally brings on an economic downturn – there is still spare capacity globally, growth in private debt remains moderate, investment as a share of GDP is around average or below, wages growth and inflation remain low and we are yet to see a generalised euphoria in asset prices.
  • Fourth, global monetary policy remains very easy with the Fed continuing to raise rates gradually, the ECB a long way from raising rates and tightening in Japan years away.
  • Finally, share valuations are not excessive. While price to earnings ratios are a bit above long-term averages, this is not unusual for a low inflation environment. Valuation measures that allow for low interest rates and bond yields show shares to no longer be as cheap as a year ago but they are still not expensive, particularly outside of the US.

Against this though there are a few storm clouds:

  • First, the US economy is more at risk of overheating – unemployment is at its lowest since 1969, wages growth is gradually rising and inflationary pressures appear to be picking up. The Fed is aware of this and will continue its process of raising rates. While other countries are behind the US, its share market invariably sets the direction for global markets
  • Second, global liquidity conditions have tightened compared to a year ago with central bank quantitative easing slowing down and yield curves (ie the gap between long term and short-term bond yields) flattening.
  • Third, the risks of a trade war dragging on global growth have intensified. While the share of US imports subject to recently imposed tariffs is minor so far (at around 3%) they are threatened to increase. Our base case remains that some sort of negotiated solution will be reached but trade war worries could get worse before they get better.
  • Fourth, emerging countries face various risks from several problem countries (Turkey, Brazil and South Africa), slowing growth in China, concerns the rising US dollar will make it harder for emerging countries to service their foreign debts and worries they will be adversely affected by a trade war.
  • Finally, various geopolitical risks remain notably around the Mueller inquiry in the US, the US mid-term elections and Italy heading towards conflict with the EU over fiscal policy.

A problem is that various threats around trade and Trump, Italy and China have come along at a time when the hurdle for central banks to respond may be higher than in the past – with the Fed focussed on inflation and the ECB moving to slow its stimulus and less inclined to support Italy.

What about the return outlook?

Given these conflicting forces it is reasonable to expect some slowing in returns after the very strong returns seen in the last two years. Solid growth, still easy money and okay valuations should keep returns positive, but they are likely to be constrained and more volatile thanks to the drip feed of Fed rate hikes, trade war fears, China and Emerging Market worries and various geopolitical risks. In Australia, falling home prices in Sydney and Melbourne along with tightening bank lending standards will be drags. Looking at the major asset classes:

  • Cash and bank deposit returns are likely to remain poor at around 2% as the RBA is expected to remain on hold out to 2020 at least. Investors still need to think about what they really want: if it’s capital stability then stick with cash but if it’s a decent stable income then consider the alternatives with Australian shares and real assets such as unlisted commercial property continuing to offer attractive yields.

Source: RBA; AMP Capital

  • Still ultra-low sovereign bond yields and the risk of a risking trend in yields, which will result in capital losses, are likely to result in another year of soft returns from bonds.
  • Unlisted commercial property and infrastructure are likely to benefit from the ongoing “search for yield” (although this is waning) and okay economic growth.
  • Residential property returns are likely to be mixed with Sydney and Melbourne prices falling, Perth and Darwin bottoming and other cities providing modest gains.
  • Shares are at risk of a further correction into the seasonally weak September/October period given the storm clouds noted above, but okay valuations, reasonable economic growth and profits and still easy monetary conditions should see the broad trend in shares remain up – just more slowly. We continue to favour global shares over Australian shares.
  • Finally, the $A is likely to fall as the RBA holds and the Fed hikes adding to the case for unhedged global shares.

Things to keep an eye on

The key things to keep an eye are: global business conditions PMIs for any deeper slowing; risks around a trade war; risks around Trump ahead of the US mid-term elections; the drip feed of Fed rate hikes; conflict with Italy over fiscal policy in Europe; risks around China and emerging countries; and the Australian property market – where a sharp slump in home prices (which is not our view) could threaten Australian growth.

Concluding comments

Returns are likely to remain okay over 2018-19 as conditions are not in place for a US/global recession. But expect more constrained returns (say around 6% for a diversified fund) and continued volatility.


Should the RBA raise rates to prepare households for higher global rates?

Key Points

  • The RBA should avoid calls to raise interest rates prematurely just to prepare households for higher global rates. Such a move would be Iike shooting yourself in the foot in order to practice going to the hospital..
  • Nor should the RBA mess with the inflation target that has served Australia well.
  • We don’t see it doing either and continue to see interest rates on hold out to 2020 at least and can’t rule out the next move in rates being a cut.
  • This will mean term deposit rates will stay low, search for yield activity will still help yield sensitive unlisted investments (albeit it’s waning) and an on-hold RBA with a tightening Fed is likely to mean ongoing downward pressure on the Australian dollar.


It’s nearly two years since the Reserve Bank of Australia last changed interest rates – when it cut rates to a record low of 1.5% in August 2016. That’s a record period of inaction – or boredom for those who like to see action on rates whether it’s up or down. Of course, there are lots of views out that the RBA should be doing this or that – often held and expressed extremely – and so it’s natural that such views occasionally get an airing. This is particularly so when the RBA itself is not doing anything on the rate front.

And so it’s been this week with a former RBA Board member arguing that the RBA should raise rates by 0.25% to prepare households for higher global interest rates and that the RBA should consider ditching its inflation target in favour of targeting nominal growth.

Our view – rates on hold at least out to 2020

Our view for some time is that the RBA won’t raise interest rates until 2020 at the earliest. In terms of growth, a brightening outlook for mining investment, strengthening non-mining investment, booming infrastructure spending and strong growth in export volumes are all positive but are likely to be offset by topping dwelling investment and constrained consumer spending. As a result, growth is likely to average around 2.5-3% which is below RBA expectations for growth to move up to 3.25%. This in turn means that spare capacity in the economy will remain high – notably unemployment and underemployment at 13.9% – which will keep wages growth low and inflation down. On top of this house prices likely have more downside in Sydney and Melbourne over the next two years, banks are tightening lending standards which is resulting in a defacto monetary tightening and the risks of a US-driven trade war are posing downside risks to the global growth outlook. As such we remain of the view that a rate hike is unlikely before 2020 at the earliest and can’t rule out the next move being a cut.

Raising rates to prepare for higher rates makes no sense…

Against this backdrop, raising rates just to prepare households for higher global rates would be a major policy mistake:

  • It would be like shooting yourself in the foot so you can practice going to hospital. Some might argue that given high household debt you might miss the foot and hit something more serious – but I wouldn’t go that far!
  • What’s more it’s not entirely certain that outside the US higher global rates are on the way any time soon – particularly given the risks around a global trade war, the European Central Bank looks unlikely to be raising rates until 2020 and with Japanese inflation falling again a Bank of Japan rate hike looks years away.
  • The RBA needs to set Australian interest rates for Australian conditions not on the basis of other global economies that are in different stages in the cycle – notably the US which has unemployment and underemployment of just 7.6% in contrast to Australia where it’s 13.9%.

    Source: Bloomberg, AMP Capital

  • Raising rates when there is still high levels of labour market underutilisation, wages growth is weak and inflation is at the low end of the inflation target would just reinforce low inflation expectations – causing businesses and households to question whether the RBA really wants to get inflation and wage growth back up to be more consistent with the inflation target and run the risk of a slide into deflation next time there is an economic slowdown.
  • The RBA has already provided numerous warnings that sooner or later rates will go up, effectively helping to prepare households that such a move may come and in recent times banks have raised some mortgage rates, albeit only slightly. Last year’s bank rate rises were in response to regulatory pressure and recently they have been in response to higher short-term money market funding costs as the gap between bank bill rates and the expected RBA cash rate has blown out by around 0.35% relative to normal levels. This has further reminded households of the risk of higher interest rates.

…nor does changing the inflation target

Suggestions to change the inflation target or move to some other target for the RBA get wheeled out every time we run above or below the target for a while but its served Australia well. When it’s above for a while like prior to the Global Financial Crisis some wanted to raise it, when it’s below for a while some want to cut it. And there are regular calls to move to something else like nominal growth targeting. But the case to change the target is poor:

  • The 2-3% inflation target interpreted as to be achieved over time has served Australia well. It’s low enough to mean low inflation, it’s high enough to allow for the tendency of the measured inflation rate to exceed actual inflation (because the statistician tends to understate quality improvement) and to provide a bit of a buffer before hitting deflation. And the achievement of it over time means the RBA does not have to make knee-jerk moves in response to under or overshoots because it can take time to get back to target.
  • Shifting to a nominal GDP or national income growth target would be very hard for Australia for the simple reason that nominal growth in the economy moves all over the place given swings in the terms of trade which the RBA has no control off. It would have meant much tighter monetary policy into 2011 than was the case and even easier monetary policy a few years ago when the terms of trade fell. In short it would mean extreme volatility in RBA interest rates.
  • And in any case, nominal GDP or income growth is made up of two different things – inflation and real growth – so targeting just the aggregate could lead to crazy results for example if the target is 4.5% the RBA could get 4.5% inflation and say it hit its target! Which would be nuts.
  • Finally, while low rates risk inflating asset price bubbles it’s worth noting that apart from Sydney and Melbourne home prices, the period of low rates has not really led to a generalised asset price bubble problem in Australia. And in any case as we have seen recently in relation to Sydney and Melbourne property prices – which are now falling (despite still ultra-low interest rates!) – the asset price problem where it does arise can be dealt with via macro prudential controls on lenders. Arguably, if we had moved faster on the macro prudential front around 2014-2016 then the east coast housing markets would have been brought under control earlier and rates could have come down faster in Australia and we could now be in a tightening cycle…but that’s all academic!

Bottom line

The bottom line is that the RBA should stick to its inflation target and ignore those arguing for a premature rate hike. Our assessment is that this is just what it will do and that rates will be on hold for a long while yet. In the meantime, the debate about rates will no doubt rage on.

Continuing low interest rates in Australia will mean term deposit rates will stay low, search for yield activity will still help yield-sensitive unlisted investments like commercial property and infrastructure (albeit it’s waning) and an on-hold RBA with a tightening Fed is likely to mean ongoing downward pressure on the Australian dollar as the interest rate differential goes further into negative territory.

Source: Bloomberg, AMP Capital

While a crash in the $A may concern the RBA, we saw in both 2001 when it fell to $US0.48 and 2008 when it fell from $US0.98 to $US0.60 in just a few months that the inflationary consequences of a lower $A are not what they used to be and in any case the RBA would likely welcome a fall to around $US0.65-0.70.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital



Trade war risks are escalating – but a negotiated solution remains most likely

Key Points

  • US actions in recent weeks have increased the risk of a full-blown trade war – primarily between the US and China – with a more significant economic impact.
  • So far the bulk of the tariffs are just proposed so there is still room for a negotiated solution (which remains our base case with a 55% probability).
  • But there is now a stronger risk (say around 30% probability) that some of the tariffs go into force before a negotiated solution is reached (which would be a short-lived negative for share markets) or a full-blown US-China trade war is not averted (15% probability) with deeper share market downside.
  • Key to watch for is the re-start of US-China negotiations ahead of July 6.


The threat of a full-blown trade war has escalated in the last few weeks with the G7 meeting ending in disarray over US tariffs on imports of steel and aluminium from its allies and more importantly President Trump threatening tariffs on (so far at least) $US450bn of imports from China, and China threatening to retaliate. Our base case remains that a negotiated solution will ultimately be reached, but the pain threshold in the US is clearly higher than initially thought and the risks have increased.

Background on trade wars and protectionism

A trade war is a situation where countries raise barriers to trade, with each motivated by a desire to “protect’’ domestic workers, and sometimes dressed up with “national security” motivations. To be a “trade war” the barriers need to be significant in terms of their size and the proportion of imports covered. The best-known global trade war was that of 1930 where average 20% tariff hikes on most US imports under Smoot-Hawley legislation led to retaliation by other countries and contributed to a collapse in world trade.

A basic concept in economics is comparative advantage: that if Country A and B are both equally good at making Product X but Country B is best at making Product Y then they will be best off if A makes X and B makes Y. Put simply free trade leads to higher living standards and lower prices, whereas restrictions on trade lead to lower living standards and higher prices. The trade war of the early 1930s is one factor that helped make The Great Depression “great”. As RBA Governor Philip Lowe has observed “Can anyone think of a country that’s made itself wealthier or more productive by building walls?”

Access for US exports to China and stronger protection of US intellectual property. His comments at the recent G7 meeting where he proposed completely free trade suggest he secretly does support free trade (although it’s a bit hard to know for sure!)

Most of these issues were covered in more detail here.

Where are we now?

Fears of a global trade war were kicked off in early March with Trump announcing a 10% tariff on aluminium imports and a 25% tariff on steel imports. US allies were initially exempted but China was not and the exemptions for Canada, Mexico and the European Union expired on June 1. But tariffs on steel and aluminium imports are minor at around 1.5% of total US imports. There is a risk of escalation though as the affected countries retaliate.

However, the main focus remains China. On March 22, in response to the Section 301 intellectual property review (alleging theft by China), Trump proposed 25% tariffs on $US50bn of US imports from China and restrictions on Chinese investment in the US. At the same time, the US lodged a case against China with the World Trade Organisation. China then announced “plans” for 25% tariffs on $US50bn of imports from the US with a focus on agricultural products. Then Trump threatened tariffs on another $US100bn of imports from China in proposed retaliation to China’s proposed retaliation to which China said it would retaliate.

These tariffs were put on hold after a May 19 agreement between the US and China under which China agreed to import more from the US, reduce tariffs and strengthen laws to protect intellectual property, with negotiations around the details to come. Trump initially cheered the outcome, but after domestic criticism did a backflip and announced that the $US50bn in imports from China to be subject to a 25% tariff would be finalised by June 15, which they were (with a July 6 start date set for $US34bn) and that investment restrictions would be finalised by June 30.

After China said that the May 19 deal was no more and that it would match US tariffs, Trump upped the $US100bn to a 10% tariff on $US200bn of imports and said that if China retaliates to that it will do another $US200bn. This brings the tariffs on US imports from China to $US450bn which covers 90% of America’s total annual imports from China. Along the way Trump has also announced consideration of automobile tariffs – with the outcome yet to be announced.

Rising risk of a full-blown trade war

Clearly the escalating tariff threats have added to the risk of a full-blown trade war between the US and China, and with an escalation possible between the US and its allies. The initial tariffs on steel and aluminium and proposed for $US50bn of imports from China amount to a still small 3% or so of US imports or just 0.5% of US GDP so only a trivial impact and hardly a trade war.

But if there are tariffs on $US450 of imports it’s about 18% of total US imports and will have a bigger impact. On this scale it’s inevitable that consumer goods will be impacted. And with China only importing $US130bn from the US annually, it’s proportional retaliation to US tariffs will have to move into other areas like tougher taxation and regulation of US companies operating in China and selling US Treasury Bonds (although this will only push the Renminbi up which will make things worse for China).

And of course, with US allies preparing retaliation against US tariffs on steel and aluminium (eg EU tariffs on US whiskey and Harley Davidsons) there is a danger that conflict escalates here too as the US counter-retaliates. And then there’s potentially auto tariffs.

There is also the danger that President Trump’s flip flops on policy (particularly after the May 19 agreement with China) and the confusion as to who is handling the US negotiations (whatever happened to Treasury Secretary Mnuchin who declared that the trade war had been put on hold?) has damaged Trump’s and US credibility.

Economic impact

The negative economic impact from a full-blown trade war would come from reduced trade and the disruption to supply chains that this would cause. This is always a bit hard to model reliably. Modelling by Citigroup of a 10% average tariff hike by the US, China and Europe showed a 2% hit to global GDP after one year, with Australia seeing a 0.5% hit to GDP reflecting its lower trade exposure compared to many other countries, particularly in Asia which will face supply chain disruption. At present we are nowhere near an average 10% tariff hike (the average proposed tariff on $450bn of Chinese imports is 12% which across all US imports is around 2%). So this would need much further escalation from here.

It might also be argued that the US is best placed to withstand a trade war because it imports more from everyone else than everyone else imports from it and the negative impact from the proposed tariffs (which is running around $60bn in tax revenue out of the economy) is swamped by the $300bn in fiscal stimulus boosting the US economy. Trump also feels empowered because there is a lot of domestic support in the US for taking a tougher stance on trade (particularly amongst Republicans) and his approval rating has risen to 45% – the highest in his Presidency.

And the current situation mainly just involves the US and China (in terms of significant tariff announcements), so arguably Chinese and US goods flowing to each other could – to the extent that there are substitutes – just be swapped for goods coming from countries not subject to tariffs, thereby reducing the impact.

Some reasons for hope

So far what we have really seen is not a trade war but a trade skirmish. The tit for tat tariffs triggered in relation to US steel and aluminium imports are trivial in size. All the other tariffs are just proposals and the additional tariffs on $US200bn of imports from China plus another $US200bn would take months to implement, much like the initial tariffs on $US50bn. Trump is clearly using his “Maximum Pressure” negotiating approach with US Trade Representative Lighthizer saying on Friday that “we hope that this leads to further negotiations”. If the US didn’t really want to negotiate, the tariffs would no longer be proposals but would have been implemented long ago. And while Trump is riding high now as he stands tough for American workers, a full-blown escalation into a real trade war with China come the November mid-term elections is not in his interest. This would mean higher prices at Walmart and hits to US agricultural and manufacturing exports both of which will hurt his base and drive a much lower US share market which he has regarded as a barometer of his success. US Congressional leaders may also threaten intervention if they feel Trump’s tariff escalation is getting out of hand. So negotiation is still the aim and China, given its May agreement, is presumably still open to negotiation. So our base case is that after a bit more grandstanding for domestic audiences, negotiations recommence by early July allowing the July 6 tariffs to be delayed as negotiations continue, which ultimately lead to a resolution before the tariffs are implemented. Share markets would rebound in response to this.
But given the escalation in tension and distrust of President Trump we would now only attach a 55% probability to this. The other two scenarios involve:

  • A short-lived trade war with say the tariffs starting up on July 6 and maybe some more but with negotiations resulting in their eventual removal (30% probability). This would likely see more share market downside in the short term before an eventual rebound.
  • A full-blown trade war with China with all US imports from China subject to tariffs and China responding in kind, triggering a deeper 10% decline in share markets on deeper global growth worries (15% probability).

What to watch?

Key to watch for is a return to negotiation between the US and China by the end of June. The renegotiation of NAFTA and proposed retaliation from the EU against US steel and aluminium imports are also worth watching.

Why are Australian shares so relaxed?

Despite the trade war threat Australian shares have pushed to a 10 year high over the last few days helped by a rebound in financial shares, a boost to consumer stocks from the likely passage of the Government’s tax cuts (even though these are trivial in the short term) and strong gains in defensives. Given that China takes one third of our exports the local market would be vulnerable should the trade war escalate significantly. But if our base case (or even a short-lived trade war) plays out the ASX 200 looks on track for our year-end target of 6300.
Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital



Making the most of rental and holiday properties

Given increasing government focus, now’s the time for investors to be more savvy about their rental and holiday properties.

Although a rental or holiday house can be a good way to build wealth or diversify your existing property portfolio, investors need to take care before diving in, as the Australian Taxation Office (ATO) is paying much closer attention to the deductions that go hand-in-hand with property investing.

“The government is tightening things up – you can see that from the new legislation – while the ATO is increasingly focussing on this area,” explains Peter Bembrick, a taxation services partner in the Sydney office of national accounting firm, HLB Mann Judd.

“It has gone from the ATO just looking at the area – as it is with work deductions – to it now being a sufficiently serious issue for the government to make things black and white with legislation.”

Goodbye to travel deductions

The most recent legislative target is the expenses property investors have traditionally claimed for travelling to inspect their holiday home or investment property. The size of these deductions is clear, with Treasury anticipating $540 million in additional revenue over the next four financial years from eliminating these claims.

“People were taking the mickey and making excessive deductions when they were really using the trip for a holiday. It’s clear in many situations what the intent was with the travel,” says Bembrick.

“The question is whether this was a cost that was really necessary when you were employing a property agent.”

Since 1 July 2017, property investors can no longer claim for travel to maintain or collect rent for their residential rental property, or to inspect it either during or at the end of a tenancy unless they are in the business of property investing.

In addition, travel expense claims for preparing the property for new tenants, or visiting an agent to discuss the rental property, will also cease.

To avoid problems, the key is only claiming deductions for periods when the property is rented out, or genuinely available for rent.

Holiday homes under the microscope

The ATO is also taking a closer look at deductions where holiday homes are partly used by the owner. Of particular interest are properties that are vacant for long periods, or where the owners reserve it for family and friends.

“If a holiday home is tenanted full-time, tax deductions are available. It’s more of an issue when a holiday home is only used for generating income part of the time,” explains Bembrick.

To avoid problems, the key is only claiming deductions for periods when the property is rented out, or genuinely available for rent.

For example, if you rent the property for nine months but use it privately the rest of the year, you can only claim three-quarters of your annual expenses.

Simply claiming your property is available for rent will not cut it with the taxman either, as owners must widely advertise their property to potential tenants, place reasonable conditions on renters, and not refuse rentals without adequate reasons.

Tips for potential investors

If undeterred by the tighter rules, potential investors should still carefully consider the potential for wealth creation, not just the lifestyle or tax benefits.

“When it comes to these sorts of investments, don’t just be driven by the tax considerations, think about the return on investment and the potential capital gain,” says Bembrick.

This is particularly important if you plan to negatively gear. “You need to remember you are losing money when it comes to negative gearing. You really need to assess the investment side-by-side with the potential capital gains to ensure it is a worthwhile investment.”

As with everything related to tax, having paperwork to back up deductions is vital.

“If you are paying the local handyman in cash to fix up the property or maintain the gardens, you could have a problem,” warns Bembrick.

Claiming large deductions when the property is only tenanted for short periods is also a recipe for trouble. “Check the amount of deductions you are claiming make sense in relation to the income being generated,” he says.

Get the right advice

Navigating the rules around owning a rental or holiday property can be difficult, so speaking to a financial adviser can help you find the approach best suited to your future needs.’


Putting the ‘I’ in education: why we’re investing in disrupting the education system in China

Alicia Gregory, Head of Private Equity, MLC

For millions of mainland Chinese students, long days filled with rote memorisation and high-pressure testing are part of everyday life. But as the Chinese economy continues to grow, a middle class has emerged and they have different expectations of the education system for their children that the existing Chinese system simply doesn’t meet.

These individuals have started to embrace an English-based, western-style education system which aims to develop essential skills such as critical thinking and innovation, and seeks to nurture the strengths of each child, rather than label them as ‘good’ or ‘bad’ students based on exam results.

Promoting individualism in the communist state

Education has always been a tightly regulated area in China, as it can directly influence the next generation and facilitate social mobility. Although in China there is an overall trend towards deregulation, years 1 through 9 are defined as a ‘mandatory education period’ which remains tightly controlled by the government.

However, the for-profit sector has really started to take off in China. Deloitte describes China’s education industry as ushering in a “golden age”, with expansion in terms of both industry size and market activity.1

Private school penetration has increased from 11% in 2009 to 19% in 2016 as private schools have started to become accepted as mainstream in China. While private schools for local Chinese children must follow the government curriculum for years 1 to 9, they are not as tightly controlled by the government and have more freedom to design programs, improve facilities and charge higher tuition fees. Indeed, private education has been encouraged in China, in part to bridge the shortage of public funds and resources.

Rising demand for second languages

Within the growing demand for private schools is an increasing interest in bilingual international schools. While at face value it would appear at odds with state-controlled education, by encouraging the development of local private international schools, the Chinese government can still have some influence over the curriculum and still benefit the domestic economy. This remains far more palatable than losing these students, who would otherwise move to overseas high schools to study.

In 2013 the Chinese government introduced policies that encouraged private schools to launch international curriculum programs under a set of specific rules and guidelines. This has seen total enrolments at international schools in China grow from 177,000 in 2014 to around 245,000 in 2017.2 Though China’s economic growth rate is slowing, the desire of middle class parents to send their children to bilingual international schools continues to grow, mainly because they believe that a high quality education is an investment in the future of their children.

Also in 2013, the Chinese government relaxed the one-child policy to stimulate the birth rate. This policy should result in the student population steadily increasingly, further supporting demand for international schools.

Types of international schools in China

International schools in China can be broadly divided into two categories:

  1. Traditional international schools for expatriates: these schools have historically dominated the international school market, charging around US$40,000 pa and catering mainly for expats living with their families in China. They can only accept children of foreign nationals. These schools are usually lightly regulated when compared to schools for local children, especially in terms of the curriculum. Since 2010, the demand by traditional expats has stabilised and slowed down, as a lot of expatriate families have left China.
  2. Bilingual schools for domestic students: these schools can accept children of Chinese nationals, offering an integrated program of both Chinese and foreign education. They target upper-middle class families in China that are willing to pay premium fees, of around US$15,000-35,000 pa, in order for their children to receive high-quality education and eventually study at high profile universities abroad. The curriculum is usually an international one recognised by global educational institutions, emphasising English fluency and well-rounded development. Facilities are better at these schools, with smaller class sizes of around 25 students per class compared to around 50 per class across the broader industry.These bilingual schools for domestic students have emerged to try to fill the gap in the market for quality education that prepares Chinese students to be well-rounded and active participants in the global economy. This segment is one of the fastest-growing in the Chinese educational sector, growing at nearly twice the pace of the already rapidly expanding private education market. J.P. Morgan sees a trend of shifting focus from expat schools to domestic bilingual schools3, as demand for high quality domestic kindergarten to year 12 (K-12) international schools from Chinese students will exceed supply.

Quality continues to be the ultimate differentiator

China has a cultural predisposition for spending on a child’s education, as historically two-income families have focused resources on only one child. Recent changes in government policies discouraging conspicuous consumption has also resulted in more income becoming available for socially and politically acceptable spending such as education. Education spending is often cited as the second or third highest category of family spending after housing and food.

While there are many factors families consider when selecting a school, education quality continues to be the deciding factor.

Many parents scramble to enrol their children in the best kindergartens, which then leads to the best elementary schools, high schools and, finally, universities, with many hopeful of a place at an Ivy League school in the US, Oxford or Cambridge in the UK.

The MLC Private Equity team are strong supporters of the education industry, not just for its attractive market dynamics, but also because its ability to transform people’s lives has financial implications for our investors.

While we’re aware the investment case may not play out exactly as we expect, we’ve deliberately focused on backing only the highest quality educational institutions. We have invested in an emerging network of six schools in China which has achieved among the best academic results of all international schools in Shanghai.

Like many of the top private international schools, these schools focus on the education of values and responsibilities and nurturing students’ individual personalities and creative developments, rather than an exam-oriented style of education. Their success is already attracting significant international interest. Yale is in discussion with the schools to be their exclusive partner in China to set up joint-branded kindergartens – a clear testimony to the schools’ focus on providing a quality education for their students.

1 ‘Golden age of China’s education industry’, Deloitte, May 2016.

2 China Maple Leaf Educational Systems Limited Annual Report 2015/16; Frost & Sullivan Report 2017.

3 J.P. Morgan Securities (Asia Pacific), China Education Service Sector, June 2017.


Financing your asset purchases

For most businesses, the decision for financing your asset purchases is very clear cut as it boils down to a choice between a lease or a chattel mortgage. There are, however many businesses who may find a short term rental contract the best option available. For businesses that may not qualify for traditional bank lending or have specific needs, short term rental finance can offer many benefits, please consider the following list:-

asset purchases

  • Start up equipment finance when banks don’t want to know you
  • No capital outlay, keep your cash for more important things
  • 100% tax deductible monthly payments
  • Fast approval – 24 – 48 hrs / easy application
  • No financials under $50,000*
  • Maxed out capital expenditure budget
  • Choices available at the end of the 1 year term

Once the rental term is over, the business has 4 choices:-

  1. Hand the equipment back as it has served its purpose
  2. Continue to rent
  3. Buy the equipment outright and get a 75% rebate on all the rental repayments made
  4. Switch to a ‘rent-to-own’ plan for another 3 years where the equipment is owned at the end of the term

CostVSFlexThe flexibility of these options along with the net cost to the business is something that should not be over looked. Lease and chattel mortgages can tie businesses down for long term periods and reduce flexibility. On the other hand, equipment hire is very expensive and may leave you open to availability and weather issues. Consider the adjoining chart.

The rental option is a pathway to ownership while at the same time presenting you with a very economic alternative to bank finance, particularly if your business fits into one of the categories highlighted above.

For example, a $30,000 service van for your business would rent for $355 per week, after 12 months the buy back price on this asset would be $20,036. Lets consider each of the end of term options mentioned above:-

  1. Hand the equipment back as it has served its purpose – The total rent paid would be $18,495 and the tax deduction claimed on these rental payments for a company would be approximately $5,550 (30% tax rate). The net payments would total $12,946, therefore by adding the end of year 1 purchase price to the net payments the rental cost of ownership would be $2,157 or $41.50 per week against having purchased the van outright. The revenue and profit generated by the asset should be well above this cost.
  2. Continue to rent – If your contract ran for a few more months, you could still exercise the above option at the completion and each rental payment would continue to add to your rebate total if you decided to purchase the asset.
  3. Buy the equipment outright and get a 75% rebate (net of tax) on all the rental repayments made – Net of tax requires the deduction of 10% input tax credits claimed from the 12 month rental figure before multiplying the total by 75%. This is then subtracted from the purchase price and tax is added back on for sale back to your business at a price of $20,036.
  4. Switch to a ‘rent-to-own’ plan for another 3 years where the equipment is owned at the end of the term – rental payments are reduced by approximately 30 % during this period.

*Each application is assessed on its own merits

For more information on financing your asset purchases, please contact Chris at TWM Finance on 07 3281 1226.

misguided loyalty

Banking on your misguided loyality

If you have been banking with your current lender for more then 10 years, then it may be that you have a dose of misguided loyalty to that lender, and they love it! In a recent Canstar Blue consumer survey it was revealed that 75% of respondents were satisfied with the customer service at their bank.

misguided loyalty

Is that it? Only 75%!

I also suspect that it is much lower then this number if the respondents were to dig deeper into the loans they had, found out exactly what they were paying for and what they were really using. You should not assume that your lender is offering you a great credit card and home loan rate, you need to know for sure.

What can you do about it? To see if you pass the misguided loyalty test, answer the following three questions. If you can not confidently answer each one with a yes, then you fail the test:-

  1. Do you know what the exact interest rate is on your current home loan?
  2. Do you know what loan features you have and if so, are you are using what you are paying for?
  3. Has your local bank manager has contacted you in the last two years to say hello and see how you are going with your home loan?

Don’t line your lenders pockets! Paying off your mortgage is one of the smartest things you can do for yourself and your family. Here is a three step plan of action to make sure you are on the way to being mortgage free:-

  1. Know your numbers. How much principal did you pay off last month compared to interest? Knowing this number will give you a true sense of how much better you may be able to do with a more suitable home loan.
  2. Tidy up your budget. The extra effort put into identifying where you can find an extra $100 per month can take years off the life of your loan. If you can couple this with a better rate then you may be well ahead of the eight ball.
  3. Motivate yourself. In order for this to work you will need to print out your amortization schedule, this is a table showing the amount of principal and the amount of interest that comprise each payment so that the loan will be paid off at the end of the term. Check out the great calculator on the following site, amortization schedule calculator. Use this to keep track of your mortgage payments and note the difference that extra payments make to the loan term and interest charged.

On a final note, you should know that the real cost of your mortgage is the opportunity cost. The estimated ‘real’ cost of your home is three times what you repay, that is three houses or if you are comfortable with misguided loyalty, one house for you and two for the bank. Extra repayments short circuit your amortization schedule because an extra 10% off your mortgage payments may be five years off your loan term.

If you feel you have been betrayed by your lender and are guilty of having a misguided loyalty, if you need help to work out your numbers, or if you would like some advice on which loan may be suitable for you, please give me a call on 0439 663744 and we’ll see what you may be able to save.


investment yield

What is Investment Yield?

What is an investment yield? The yield an investment provides is basically its annual cash flow divided by the value of the investment.

  • For bank deposits the investment yield is simply the interest rate, eg bank 1 year term deposit rates in Australia are around 2.4% and so this is the cash flow they will yield in the year ahead.
  • For ten year Australian Government bonds, annual cash payments on the bonds (coupons) relative to the current price of the bonds provides a yield of 2.5% right now.
  • For residential property the investment yield is the annual value of rents as a percentage of the value of the property. On average in Australian capital cities it is about 4.2% for apartments and around 2.8% for houses. After allowing for costs, net rental yields are about 2 percentage points lower.
  • For unlisted commercial property, investment yields are around 6% or higher. For infrastructure investment it averages around 5%.
  • For a basket of Australian shares represented by the ASX 200 index, annual dividend payments are running around 5.3% of the value of the shares. Once franking credits are allowed for this pushes up to around 6.9%.

Investment Yield

Yield and total return

The yield an investment provides forms the building block for its total return, which is essentially determined by the following.

Total return = yield + capital growth

For some investments like term deposits the yield is the only driver of return (assuming there is no default). For fixed interest investments it is the main driver – and the only driver if bond investments are held to maturity – but if the bond is sold before then there may be a capital gain or loss.

For shares, property and infrastructure, capital growth is a key component of return, but dividends or rental income form the base of the total return. Prior to the 1960s most investors focused on yield, particularly in the share market where most were long term investors who bought stocks for dividend income. This changed in the 1960s with the “cult of the equity”, as the focus shifted to capital growth. It was pushed further through the bull markets of the 1980s and 1990s. Similarly at various points in the cycle real estate investors have only worried about price gains and not rents.

Key issues for investors to consider

In searching for a higher investment yield investors need to keep their eyes open. It’s critical to focus on opportunities that have a track record of delivering reliable earnings and distribution growth and are not based on significant leverage. In other words make sure the yields are sustainable. On this front it might be reasonable to avoid relying on some Australian resources stocks where current dividends look unsustainable unless there is a rapid recovery in commodity prices.

To get your finances heading in the right direction, call our office now, make an appointment and we will conduct a thorough review to ensure your portfolio matches you goals and you are getting your share of investment yields. To read the entire article from AMP’s Dr Shane Oliver, please go the the following link, Oliver’s Insights.

2016 Investment Themes

2016 has started with many of the same fears/investment themes as seen in 2015. This note provides a summary of key 2016 investment themes on the global economic and investment outlook in simple point form.

  • Global growth of 3% or just above, with the US around 2%, Europe and Japan lagging and China running around 6.5%, but Brazil and Russia still in recession.
  • Scope for a cyclical bounce or at least stabilisation in commodity prices, but in the context of a continuing secular downtrend in response to excess supply.
  • Continuing low inflation on the back of global spare capacity and weak commodity prices, notably oil, the over riding investment theme among them all.
  • Continuing sub-par growth in Australia of around 2.5% for most of the year in response to falling mining investment, the commodity price slump and budget cuts but with the hope of some improvement by year end.
  • Easy monetary conditions with the US very gradually raising rates (two hikes at best, but the risk is one or none), but on going easing in Europe, Japan, China and Australia.
  • A further rise in the $US but at a slower rate than seen over the last two years, with the $A falling to around $US0.60.
  • Modest gains in shares, with global shares outperforming Australian and emerging market shares again.
  • Solid returns from commercial property and infrastructure, but soft gains of around 3% for Australian residential property prices as Sydney and Melbourne slow.
  • Low returns from low yielding cash and bonds.
2016 investment themes

The key risks for 2016 investment themes

  • The Fed could prove to be too aggressive in raising rates, and even if it isn’t the fear of this could continue to weigh.
  • The combination of the Fed and low oil prices causing ongoing problems for indebted US energy producers could cause more weakness in credit markets.
  • Political uncertainty could remain a threat in the Eurozone, particularly in relation to Spain (after its messy election) and around populist/extremist parties gaining support.
  • Chinese growth could disappoint with policy uncertainty around Chinese shares and the Renminbi continuing to unnerve investors.
  • Plunging emerging market currencies (and commodity prices) could trigger a default event somewhere in the emerging world on US dollar debt.
  • The loss of national income from lower commodity prices and the continuing unwind in mining investment and a loss of momentum in the housing sector could result in much weaker Australian economic growth.
  • More geopolitical flare ups – eg, South China Sea, tension between Sunni Saudi Arabia & Shia Iran, terrorist threat.
  • Factor X – there is always something from left field. Last year it was China fears.

Five reasons why the RBA will likely cut rates further in 2016

  • The outlook for business investment is still weak.
  • To offset a slowing contribution to growth from housing.
  • Commodity prices are weaker than expected.
  • The $A needs to fall further.
  • To offset the monetary tightening from bank mortgage rate hikes for existing home owners.

What does all this mean for your share portfolio?

For the full article please go to AMP economist Dr Shane Oliver

There is a lot of pessimism around and monetary conditions are very easy and likely to get easier still as while the Fed may start to tighten other central banks are still easing. A global recession is unlikely – deep and long bear markets normally require a recession (in the US at least). Share valuations are good, particularly against low bond yields and interest rates, showing 2016 investment themes give credence to some optimism.