Making sense of the Budget

Summary: A highly optimistic Budget presented by the Government has clear bullish share market implications.

Key take-out: Treasury is clearly pinning Australia's growth forecasts on what happens in China and East Asia rather than in the US and Europe.

If Treasury is right, then at least for the next year the world is headed for continued coordinated growth. And better still, if Westpac rather than UBS is right about the Australian housing market, the great threat hanging over our share market is not going to pull the country down.

Before looking at the parts of Australia to benefit, let's see how Treasury is looking at the world.

China grew by 6.9 per cent in 2017, and in 2018 Treasury says China's growth will still be high at 6.5 per cent, followed by 6.25 per cent and 6 per cent, respectively, over the next two years. In other words, growth remains high, but it steadies (albeit at a high level). Like Australia, Treasury believes there will be no financial crisis in China.

That's good news for commodity prices and our miners, but there is one caveat – demand for Australian iron ore will start to flatten in 2019 and beyond as China's scrap output increases in a period of small falls in growth. Scrap steel is a rival raw material to iron ore.

The US grew by 2.3 per cent in 2017 and Treasury expects it to rise at a higher rate (2.75 per cent) in 2018. But then, despite the Trump stimulation, Treasury expects US growth to slip to 2.5 per cent in 2019 and then for it to head down sharply to 2 per cent in 2020.

What that means is that sometime in 2019, the Federal Reserve may be thinking that interest rate increases have gone far enough, and in 2020 it could even be thinking about reducing them. Again, if Treasury is right, then that means that we are not headed to very large interest rate increases, and this is also the message from the long-term US bond market.

I highlight this forecast because it is in line with my thinking. But Treasury will go further and say that in the Euro area the 2017 GDP rise of 2.4 per cent is not going to be maintained. Indeed, it will fall to 2 per cent in 2018 and then 1.75 per cent in 2019, and to a small 1.5 per cent in 2020.  That's a bit scary.

Now to Australia

But now let's look at what they are saying about Australia's real gross domestic product. Unfortunately, they quote different years and the measurement criteria may be different, but we are expected to achieve 2.75 per cent in 2017-18 and then rise to 3 per cent in 2018-19, and 3 per cent again in 2019-20. In other words, we rise above the US.

Clearly Treasury is relating the Australian growth rate to that of the increase in China and East Asia rather than the US, Europe and Japan (where growth falls below 1 per cent in 2020, according to Treasury).

Now, as we all know, Treasury forecasts are not always right, so be careful – we could see our interest rates again rise above the US before the decade is out. That would strengthen our currently weak currency, but this is a year or two away.

Overall

It was clear from the Budget that Treasury and the Government is highly optimistic about the future economic times in Australia. And, if they are right, there are clear bullish share market implications.

When it comes to the housing industry, Treasury clearly expects a steadying of new investment and is concerned that if the lower prices in Sydney and the moderation in Melbourne was to continue, it might curb new developments.

Conversely, the global investment house UBS believes that the restrictions to be placed on bank lending will curb the amount of money that banks will be able to lend, and this will reduce prices. In fact, this is a credit squeeze.

There is nothing of that in Treasury forecasts. If UBS is right, then not only will egg be splattered across the Westpac board and management but also all over Treasury.

The Budget shows that there has been a strong rise in non-business investment, and that money has flowed into hotels and other tourist places, alongside aged-care facilities and health services. And there is also a reasonable pipeline of work in commercial buildings, especially in offices located in Victoria and New South Wales.

Treasury expects that to continue with additions in infrastructure programs, which means that the outlook for building supply companies continues to look strong.

The Government is going to push corporate tax cuts harder and use them as a weapon in the Senate. The fact is that last year's levy on bank loans will rise to $20 billion over the next 10 years – not that far short of two thirds of the $35 billion that the company tax reductions are expected to raise.

The bank levy is the argument that the Government will use to try and convince Pauline Hanson, Derryn Hinch and other crossbenchers to vote for the company tax cuts.

That is a warning that even if Westpac is right about housing, it is not all milk and honey for banks due to the levy and the Government's plan to introduce a ban on exit fees for superannuation funds. That move that will affect some wealth management operations in an environment where banks are looking to sell.

Finally, one of the fascinating aspects of the Budget is that in the two years to 2018-19 the Government has or expects to increase income by some $60 billion, of which just over $20 billion will come from company taxes and $24 billion from income taxes.

The main providers of the higher company tax revenue are the miners, reflecting higher commodity prices. But that income tax increase shows the effect of greater employment and the moving up through the tax brackets, even with overall moderate rises in salaries, but most importantly it reflects higher total incomes.

Personally, I suspect that large amounts of that extra income are going to be spent on loan repayments on the higher value houses. It is certainly not going into the retail area.