China and super: Big changes afoot

Chinese policy changes will impact our miners, but our Government’s super plans will bite sooner.

Summary: China’s shift away from energy-intensive industries to consumer demand will reduce the reliance on Australian minerals over time. But, for local investors, the biggest short-term threat is the Government’s plans to grab more revenue from superannuation.
Key take-out: The Government clearly has superannuation in its sights, and a stealth wealth tax on those with $1 million or more is still a possibility.
Key beneficiaries: General investors. Category: Portfolio management.

What a huge week. China declares it will cap coal burning at current levels and reduce its emphasis on energy-intensive industries. And, in Australia, the government caves in on its planned superannuation attack but flags another attack. I am going to comment on both subjects.

Let’s start with China.

Here we see a good sign that the Australian market is over-extended and due for a correction, as I indicated in last week’s webinar. And although that does not mean it will suddenly collapse, this week I suddenly felt I should take action.

China signalled to Australia this week that it was changing direction. Our mining analysts retorted that China would simply not be able to make that change and that it was business as usual.

I immediately recalled what we said about China in the 1980s – it would never be able to convert to a major industrial powerhouse. Our analysts were a wrong then and I believe they will be wrong this time.

That’s why I made sure this week that I had no exposure to coal assets and was low in other mining assets. The money was switched to yield assets. That action is the reverse of what many brokers are now telling clients to do. I will probably be wrong in the short term, but I believe the Chinese have no choice and I am a long-term player.

For a long time I have been concerned about the pollution in Beijing where living must be a horrible experience during parts of the year. The TV news vision of recent weeks in Beijing has underlined this view.

China has a vast industrial powerhouse making steel and other products to support a capital investment program that contributes about 50% of the economy. That’s way out if line with every other country in the world.

Large amounts of the infrastructure investment are not really needed. Tens of thousands of apartments are built and lay empty because they are too expensive for Chinese to afford. China has started another round of the same stimulation, so Australia says that all is well again.

But China’s State Council declared that it was capping coal usage around current levels as part of the five-year plan to 2015. The message that was delivered to all those who would listen were that the country was shifting from an emphasis on energy-intensive industries to consumer demand. That includes steel, where Australia is the major provider of iron ore

To make sure we got the message, the new leadership in China announced plans to double consumer income by 2020 and signalled mechanisms to lift interest rates on China’s vast savings. The rates on these savings have been kept very low so as to fund capital works.

Obviously making such a change from capital to consumer demand means that growth could be affected and unemployment might rise. But at some point it has to be done, and a change in leadership in China makes now the right time.

It will not happen overnight, but all this spells great long-term danger for growth in Australia’s main industry, mining. We will require an adjustment just as big as China’s.

It means to stimulate our economy interest rates will have to fall. So will our dollar.

The trouble with highlighting a long-term danger at this time is that it is probably much too early. But, as you know, I have been apprehensive about the long-term effect of the rise in oil and gas production that looms as a result of the big expansions planned for the US and Iraq.

But if you are a long-term player, you make your move when you see it and do not worry about the timing. However that’s not a view for everyone.

Meanwhile I think the indications from the Reserve Bank are it is looking to lower rates further and there is greater pressure coming on the banks to follow official rates down. That means lower term deposit rates, so if you are investing in term deposits, and don’t need the money, take some longer-term securities.

And the good news is, this year banks are likely to hold or slightly increase their profits so dividends are not in jeopardy. That will underwrite the income sources for a large number of superannuation funds that are funding pension obligations.

On superannuation I still have a deep-seated fear that the Labor government is going to attack our superannuation despite the retreat from taxing payouts to those over 60 who have $1 million or more in a fund.

With others, I have been alerting the government about the unfairness of attacking people with $1 million to $2 million in superannuation.

But you can see steeliness in the eyes of Wayne Swan and Penny Wong, which indicates they still want to plunge the knife into the superannuation movement on the basis that it is “middle class welfare”. But their new plan of taxing income based on balances in superannuation funds would be an administrative nightmare.

On the optimistic side, the backdown took place because the Government came to understand the electoral backlash. If it finds another, even more complex way to attack superannuation, the backlash will be even greater. The Government’s simple problem is that it wants to invest a large amount of money in both the Gonski education spending plan and the disability insurance plan. These are very worthwhile exercises but they require state government money and the states simply don’t have any money, partly because the Commonwealth has taken a lot of it away.

Nevertheless the Government will try to proceed with those plans and at least attempt to fund them via superannuation. If the government actually lifts taxes on superannuation income above $1 million, the community revolt at the election in September will be quite something.

Unlike the Government, Tony Abbott and his Coalition don’t need to attack the superannuation piggy bank because they are going to get their savings via rationalising the state and federal public services to avoid duplication. The savings are monumental. They will also dismantle vast areas of red tape, which are very costly to implement. Gillard will respond by running her campaign on the basis of the public servants’ jobs to be lost under Abbott. I think it is still possible that she might have a chance of winning on that basis, but not if she is also attacking superannuation. We are, of course, assuming no monumental error by the Coalition.

Nevertheless the superannuation debate should focus Eureka Report readers on the reasons they are saving through superannuation.

A large number of Australians are not saving in super for retirement. Their retirement assets are housed in negatively geared property, or even sometimes in share portfolios. They may be also housed in a large investment in the residential home. For those people, superannuation is the way in which money is saved to pay off the liabilities that go with their long-term investment commitments that are outside of super. Increasingly people are also using the ability to leverage superannuation to buy a rental house within the super fund. Once again that is not the traditional use of superannuation.

People undertaking those sorts of activities with their super will use what money they have left over in super (after paying liabilities) when they get to aged 60 to improve their lifestyle and make it easier to live on the pension. Accordingly there is a huge industry massaging superannuation so that the pension is maximised. One million dollars is not enough to fund a pension to live on, and if a sum as low as that is bought into the higher superannuation tax ambit then the financial planners will massage that money in just the same way they have been massaging lesser sums.

If your aim is to use superannuation as a retirement vehicle and not rely on the government pensions or some other form of saving outside of superannuation, then you are going to need at least $2 million or probably more. And for a great many people the only way to reach that figure will be to invest in superannuation using tax-paid dollars, which is something I do. But to do that requires certainty.

If Tony Abbott gets to power then a different investment climate is going to emerge. Abbott is planning a major investment in infrastructure assets. At this stage, Abbott and his treasurer Joe Hockey have not yet grasped the significance of the self-managed superannuation movement to funding infrastructure. They are probably still thinking about trying to sell new projects to the Future Fund and overseas superannuation funds. But between now and election time it will be our job to explain to them that there is money available in the self-managed fund movement to fund soundly organised and funded infrastructure projects.

New South Wales is looking to put a toll on roads that currently exist but do not carry a toll. That will be politically unpopular, but it might be more popular if the self-managed superannuation funds owned by people who live nearby receive the benefit of a well-structured security based on those tolls. Infrastructure assets are an excellent way for self-managed funds that are funding retirement to invest a portion of their assets. The trouble in Australia is that there is not that many of them and those that exist are often too highly leveraged.

I think we can greatly increase the stability of self-managed funds and lessen their dependence on the sharemarket and bank deposits. That doesn’t mean an exit from these products, merely a rebalancing of the portfolio. The Abbott infrastructure blitz is terribly important because around 2015 there will be a substantial slowdown in new mineral project investment and a lot of construction labour will come on the market. It makes a lot of sense to have the projects ready for them and the capital available to fund those projects.

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