Mini dramas fail to undermine a week of good prospects

A shock bank tax, a dramatic dollar dive and a horror mini-budget notwithstanding, this has been a pretty good week for long-term investors.

A shock bank tax, a dramatic dollar dive and a horror mini-budget notwithstanding, this has been a pretty good week for long-term investors.

First, the bank levy. It's a budget fiddle because the money raised will be an accounting entry that bulks up budget revenue, but it will also be set aside to support the government's guarantee on retail deposits of up to $250,000.

It's not a perfect user-pays structure, because the banks may not pass the charge straight through to deposits. They can lay it off in other places, too, including their lending rates, and their decisions will, as always, be influenced by how heavily they are competing.

It is a system backed by the top financial regulators, however, and, while it may carry some political risk for the Rudd government, it will not devastate bank profits. The 0.05 per cent levy will raise $733 million in the 18 months after its start in January 2016, and the four big banks lifted their statutory profit by 11.7 per cent to $18.1 billion in the first half of their current financial year.

Arguments a levy is not needed in this country ignore the fact banks are ramping up deposits in their funding mix as part of a world-wide regulatory push. Over-reliance on short-term debt was their key weakness in the financial crisis, and a deposit levy is a logical way for the government to charge a retail deposit insurance premium.

The mini-budget the government released on Friday also does not materially change the investment goalposts.

A $33.3billion four-year slide in tax collections combine with measures including the early termination of the carbon tax ($3.8billion) and other changes to push the forecast deficit for this financial year from the May budget's prediction of $18billion to $30.1billion, and the 2014-2015 budget deficit from $10.9billion to $24billion. The budget's estimate of an $800million surplus in 2015-2016 is replaced with an estimate of a $4.7billion deficit, followed by a surplus of $4billion the following year.

Savings of $17.4billion between this year and 2016-2017 as expected include four separate annual 12.5 per cent rises in tobacco taxes ($5.8billion), a crackdown on novated leasing ($1.8billion) and the bank levy.

The government is also increasing its public service efficiency dividend target from 2 per cent to 2.25 per cent ($1.8billion over three years), increasing the threshhold for lost superannuation to be transferred to the Australian Tax Office from $2000 to $4000 in December 2015 and from $4000 to $6000 in December 2016 ($582million), and slowing the growth of foreign aid ($879million).

The mini-budget does not upset the consensus on both sides of the political divide for relatively tight fiscal policy, however.

It is a strategy that has its critics: visiting Citigroup chief economist Willem Buiter confessed this week to being bemused by what he called a surplus of fiscal virtue in Australia and on Thursday National Australia Bank chief executive Cameron Clyne said the government was ignoring a unique opportunity to raise triple-A rated debt to fund long-term infrastructure development and renewal.

But it is also a strategy that is entrenched.

That means the weight will stay on the Reserve Bank to provide enough stimulus to offset fiscal tightness and lift the non-resources economy as the resources sector investment boom fades, and the news on that front this week was encouraging.

The Reserve Bank cut its cash rate from 4.75 per cent to 2.75 per cent between October 2011 and May this year, and Reserve Bank governor Glenn Stevens said on Tuesday the central bank saw no "serious impediment to further easing".

He also spoke more guardedly than he has in the past about the ability of the non-resources sector to fill the growth gap a retreating resources boom creates.

The market's verdict after the speech was that a cash rate cut is a certainty when the Reserve meets on Tuesday, and another cut later this year is possible. The dollar was at US91.6¢ before Stevens spoke. It was just above US89¢ on Friday afternoon and has fallen by 15.6 per cent since mid-April, delivering stimulus that buttressed the Reserve Bank's rate cuts.

The news overseas this week has been good, too. The US markets rallied on news that manufacturing activity expanded at its fastest pace in two years, labour market data for the US was also strong, and manufacturing indices in Europe also jumped, supporting a glass half-full view that Europe finally may be climbing away from the recession that the global financial crisis and the European sovereign debt crisis caused.

The Bank of England, the European Central Bank and the US Federal Reserve left their key interest rates at record lows (that also helped push our dollar down), and the Fed did not set a firm date for the first incremental retraction of its $US85billion ($95.5billion) a month quantitative easing program.

The US economy looks to be strong enough to persuade the Fed to begin retracting quantitative easing next month as the market expects, although it's worth noting that the Fed did sound some concern that inflation in the US is now too low.

None of this should prompt a sharemarket leap. The US holiday season is drawing to a close, and that in the past has seen momentum shift, but at current levels both the US and Australian sharemarkets are not cheap.

Our S&P/ASX 200 index has moved from a price-to-earnings multiple of 12.1 times expected earnings a year ago to about 14.2 times expected earnings, close to its 10-year average. After a 5 per cent gain in July, Wall Street's Standard & Poor's 500 index was trading at 15.5 times expected earnings on Thursday, well above its five-year average of 13.9 times.

Investors in both markets are anticipating earnings that are yet to come, in other words, but that is not unusual. When economies are showing signs of recovering, share prices rise in the belief that earnings increases will follow.

Will the profits be delivered? It's still too early to say, but, despite all the shock, horror and drama this week, the odds on economic recovery here and overseas are better now than they were when the week started.

mmaiden@fairfaxmedia.com.au

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