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The Market
The week: ASX and Wall Street
FYTD: ASX and Wall Street
Strong year – soft ending
As we expected at the beginning of the year 2024, it has been a good year for investing in markets around the world. Global equities, especially in the US, were the standout performers, but other markets, including Gold and Technology, had strong years.
The cost of holding cash was lower; that is, cash rates were higher than they have been for many years. 2024 was a year when returns could be generated at lower risks than we have seen since 2018.
The Australian economy held up reasonably well despite the sources of growth being driven by the government rather than business, households or investment. Inflation was more contained, but inflation remained higher than some economists and Reserve Banks are comfortable with.
Market returns on the ASX were strong but not across the board. Narrow leadership (including CBA) and stronger return from pure momentum created elevated risks by the end of the year. Weaker returns to mining and smaller companies in 2024, creating new opportunities in 2025.
Narrow leadership, excess prices for exceptionally large companies and the dominance of momentum have provided our team with signals to
- increase our cash levels, and
- concentrate on building breadth in the portfolio and
- increase our exposure to value and lower PE companies
In international equities, we have taken some profits where feasible on an after-tax basis and tilted the portfolio towards cheaper global markets. In our income securities sub-portfolio, we have continued increasing our bond exposure.
Softer outcomes in December, and especially this week, appear to be unwinding some of the excesses of 2024.
We are excited about how the market is set up for calendar 2025; for the first time since 2019, we can see large and straightforward sector dispersion. Some sectors are more expensive than ever and others are relatively cheap, this provides us with an opportunity to profit from the inevitable rebalance.
Federal Budget MYEFO: Mid-Year Budget Review
This week, we saw the Mid-Year update to the original May 2024 Federal Budget, the MYEFO. The report gives the government a stronger basis for forecasting the likely outcomes for the Budget from June 2024 to June 2025.
Rubbery forecasts
Rubbery forecasts made in March 2024 are improved with four months of actual revenue and spending FY25 and an update to the budget for changes in government policies created in the interim.
Financial markets parse the figures for change in forecast budget deficits, and the political class look for clues on the timing of elections and the size of the war chests available for future promises.
As an avid reader of the minutiae for decades, I find the quality of commentary regarding the budget limits our capacity as residents to understand the decisions being made. Limited understanding, in turn, allows politicians to obscure the critical components of the budget and instead create almost meaningless headlines.
Struggles with billions
Behavioural economists understand that humans struggle to understand differences in the scale of numbers. For households that work in thousands of dollars in their budgets, a billion dollars of government spending appears a large number, even when that number is a tiny fraction of the amounts spent.
Humans also struggle to convert aggregate figures across several years, especially when the number of years is mixed. They also struggle to switch between percentages, growth rates and whole numbers.
Overcoming inadequacies
Budget discussions exploit all our inadequacies at once. Let’s see how.
- Budget deficits are described in $billions of dollars as if the amounts were relevant to everyday life
- A deficit of $25bn in a single year appears huge, but the Australian economy is $2700bn per year, and the government plans to spend $740bn in FY25.
- Budget deficits should only be discussed in % of budget terms, but never are.
- Deficits result from two decisions: how much to tax and how much to spend. These figures should be depicted as % of GDP but rarely are.
- The size of taxing and spending represents the society’s value and is ultimately much more important than the imbalance between taxing and spending.
- Programs that politicians like are discussed as costing $Xbn over 10 years, magnifying the perceived impact, even when the impact is negligible.
- The concept that a modern Australian politician receives any attention from announcing a program that costs $100m over 4 years is ludicrous when a single change to a tax parameter or social security setting might cost 1% of GDP in 2035.
- Increases in taxes are discussed in terms of single-year impact or even in terms of $ per week. Each manipulation is effective. But the long-run impacts can be enormous. Changes to superannuation policy, the introduction of the NDIS or changes to tax policy, especially concessions, are sold as small impacts in a year. Still, their real impact is on the 20-year projections.
- Sitting in the background, some official publications try to remove some of the obscurity. These become critical, are interesting to read, and are finally being discussed. This note will look at two.
- The first is a concept called Tax Expenditures. What is a tax expenditure? Whenever a tax isn’t collected because a concession or parameter change means the person or firm could avoid paying, whilst others continue to pay, it is a “Tax Expenditure.”
- The 2nd is the difference between Cash and Underlying. Please explain. Sometimes, when the government spends money on large projects, when it lends parts of the economy money or when it funds activity with uncertain future outcomes, this spending can be removed from the underlying spending in the budget even though the cash is spent. Governments have continued to appreciate spending money that isn’t counted in the Spending. These amounts, sometimes called “below the line”, are now quite high. The figure below shows the type of spending now included; only time will tell if the Northern Australia Infrastructure Facility is repaid, same for the NBN or Student loans.
The amount of “Below the line” in the Budget is as large as the deficit itself
Source: Treasury Budget Papers, Macquarie Research
Are we stuck? Why are there no discussions about the task the government is set on achieving
David Graeber was an anthropologist who was concerned that modern societies had lost their flexibility and political creativity and “got stuck” on a single development trajectory.
After looking at budgets for more than 25 years, I am struck not by the changes but by the degree to which they remain the same. The similarity is clearest in the following chart. The blue line shows the total spending (”Payments”) as a percentage of GDP since the late 1970s. Excluding the COVID year and the spending blowout in the early 1980s, payments have sat within 23 and 27 per cent of GDP, respectively.
Taxation (“Receipts”) displays a cycle with lower taxation in recessions and a higher percentage in boom times. But again, the range over 50 years is relatively narrow, especially considering the vast growth in population and wealth, neither of which was forecast in the 1970’s.
For all of the political discussions, we appear to have generally the same preferences for taxing and spending as we did in the 1970’s.
Or more likely we drift rather than change and adapt.
Federal Govt: Payments and receipts, % of GDP
Source: Treasury Budget Papers
What drives the lack of innovation in taxation and spending?
The answer lies partly in the generally accepted purpose of government in Australia, partly in our tax expenditure decisions, and partly in the narrow range of the economy we tax.
First, consider tax receipts from 2024/25 to understand where the Federal Government’s tax revenue comes from. The total projected revenue is $663bn. Note that the GST is effectively a pass-through to the States.
Federal Govt tax receipts: Where do taxes come from – 2024/25, $bn
Source: First Samuel and Federal Govt Budget Papers
Most tax comes from individuals, and most of this tax – especially after refunds comes from income.
Excises and duties are relatively small, and taxes on capital, including within superannuation, are small.
As you may expect from a progressive tax system, 40% of the highest-income households pay the vast majority of individual taxes.
When we examine how the government spends, we can see the tight linkage between our tax and spending decisions.
Federal Govt spending payments: Where does spending go– 2024/25, $bn
Source: First Samuel and Federal Govt Budget Papers
Personal income taxes almost perfectly offset social security and welfare payments.
At least half of the budget is the income reallocation task we would expect governments to accomplish. Of course, there will be many views on how this is managed regarding who should pay and how much should be redistributed to whom, but we effectively move 13 per cent of GDP between households to create the society we envisage. As the economy grows and the level of redistribution remains similar, the budget tends to stay the same size.
Unless we have active policy discussions on redistribution, this issue will drift.
The States’ spending ($98) is similar to the GST collected ($95bn), so we can disregard this component. The remaining task the Budget needs to achieve post-redistribution is who pays for the remaining services, including Defence and Health.
At this point, budgeting becomes much harder, tax expenditures become vital, and the previous government’s decisions tend to dominate the outcomes of the new government.
The $116bn health spending (note just the Federal Government component), the Public Service itself ($46bn), and Education ($64bn) need to be funded from either Excises, Company taxes (after refunds to individuals), Other Personal taxes, or Superannuation taxes.
Company taxes face global competitive issues, and Excises have become unpopular. But given an aging population and higher Defence spending, it is natural to look for new sources of income or cuts to other spending. Matters are further complicated by the levels of industry assistance that support the Company taxes ($42bn).
Relying on Company taxes for structural government spending, such as Defence or Education, is also problematic when we consider economic cycles and the impact of our Terms of Trade. Treasury and politicians alike are circumspect when assuming that high mineral prices will last forever.
If the Terms of Trade fall, it is reasonable to expect that much of the required funding for Education and Health will disappear, and new sources .
Link between Australia Corporate taxes (% of GDP) and the Terms of Trade
Source: ABS, Minack Advisors
So why hasn’t the increase in the breadth and wealth of the economy been able to quickly generate the additional requirements of Health, Defence, and Education?
What is the outcome – how does the Federal Budget impact investment
Income
Commonwealth Budget Balance – % of GDP Pge 8
The information in this article is of a general nature and does not take into consideration your personal objectives, financial situation or needs. Before acting on any of this information, you should consider whether it is appropriate for your personal circumstances and seek personal financial advic