The top four factors driving returns this year

These key issues will decide our market's performance for the rest of 2016.

Summary: The Australian investment landscape continues to be influenced by the following key factors: cost pressures on our banking sector and the possible slicing of dividends, the impact of the currently-strong Australian dollar, oil prices and the looming reforms to negative gearing and superannuation in the lead up to another federal election.

Key take-out: Watch out for policy announcements after the May budget – the Coalition has promised it will not touch superannuation substantially, so any changes will be at odds with promises to its electorate.

Key beneficiaries: General investors. Category: Shares.

As you can see I am back in my usual Eureka slot on a Wednesday. I must say I enjoyed yarning with you all at the weekend, but you are in good hands with Alan Kohler.

And this morning (March 23) I awake to the implications of the Brussels terror attack which killed at least 34 people and may be the start of a lot of attacks, and hence the fall in tourist stocks.

Globally one of our biggest uncertainties is the fact that the cost of the refugee invasion of Europe is going to be monumental both in the amounts of money and social disruption. I fear the latest bombing in Brussels may be just the start of what is an attack on Western life style.

During the last week I have had the opportunity to talk to a number of larger players, and so I want to convey some of the latest thinking on what is taking place in the Australian economic environment that sets the scene for our share prices.

The banks will face trimmed dividends 

I want to start with banks and the impression I get is that most of them hope to hold their dividend for the current year, but that there is going to be a lot more pressure in the following 12 months. At the moment, the regulator APRA is telling the banks they must restrict their home lending growth to around the six to seven per cent mark rather than the old ten per cent level and if they don’t do that there will be another capital levy.

Banks are tightening up their lending criteria and as a result you are seeing softness in the housing market, but it is certainly not a collapse. And banks have a vested interest in maintaining stability in the housing market because if there is a sharp fall they will suffer considerable bad debts.

But all this means is that the area that has provided so much lending growth in the last few years will be restrained. Banks are working hard in reducing their costs via technology investment, but a lot of the easy cost reductions have already been achieved. There is a sense that the golden era of low bad debt, which boosted profits so strongly, is probably coming to an end. There have been considerable bad debts in loans to dwellings in the mining districts because house prices have slumped. And there is a sense that problem loans might spread but not to serious levels.

On the other hand all the big four banks have been shocked at the fact their loans to Arrium, formerly One Steel, which are unsecured, are set to suffer a major haircut. The proposed private equity offer starts with a $1 billion plus write down, but the overall global banking exposure is well above $2bn, with Australian banks taking a big slice. Part of the problem is that Arrium, armed with its big commitment from banks, signed work place agreements that substantially increased the risks for the banks. This has unsettled the banks because they know it has probably happened in other areas. The banks are hoping that they can get some growth from the small and medium business sector. And there is certainly a lot of activity particularly in Sydney and Melbourne – much of it is linked to the apartment building industry, but it goes much wider than that. A lot of it is indirectly related to the fall in petrol prices, which has substantially boosted the amount of road traffic so lifting the motor industry. And it’s assisted in consumer spending in selected areas.

But the banks will need that activity to continue, particularly as they are going to need to spend more money on technology and development if they are to compete with the rising rate of disruptors that are targeting their high margins.

Bank shares are some of the highest yielding industrials on the list and the market is clearly pricing them on the basis that there will be some trimming of the dividends.

Aussie dollar powered by iron ore

If the Reserve Bank becomes concerned with the level of the Australian dollar it can now lower interest rates without the fear of creating another housing boom. And of course lower interest rates make bank yields even more attractive, so if there does have to be some reductions in dividends during 2017 share prices may be insulated.

We are seeing a strong resurgence in the price of iron ore and oil and that resurgence, combined with our international high interest rates, is causing the Australian dollar to rise much further than the Reserve Bank had hoped for. The general view amongst the miners is that the iron ore price has gone a bit ahead of itself in its recent rebound and is vulnerable to a fall. Certainly that is the prediction of a lot of analysts. The predictions are probably right; although I get a sense that we might be surprised by iron ore production cuts from the likes of BHP and the other iron ore miners. The latest rise has given them a taste of better times and in this environment a trimming of production would have far more affect than it would have a few months back.

In the oil industry there is a greater sense of optimism because the major oil producing countries are talking to each other and although at present they don’t agree it is a good start. We have seen Russia pull out of the Syrian fighting which will make it easier for them to talk to Saudi Arabia.

BHP has some 350 million barrels of oil in the US, which is very low cost. BHP is simply sitting on that oil because it believes that one day there will be much better times and it wants to maximise the gains. And that long-term optimism can be felt around the industry although at the moment US gas prices are falling rapidly and means that BHP's earnings will be affected because it is a major supplier in to the US market. BHP shares have recovered a lot of the ground lost in the last two months in anticipation of better times. Those better times need to come about or the stock will slip back.

Watch out for post-budget policies

We are going to see a lot written about double dissolutions and elections in the next month or so but the real election battle will come after the federal budget, when the government announces its package, which is bound to include some nasty measures. And unusually the ALP has set out its package, which is spearheaded by higher capital gains tax and a taxing of superannuation funds in pension mode after a minimum amount is reached. Of course, they are stopping negative gearing on the purchasing of existing properties.

The word out of Canberra is that the Coalition is also going to be tough on superannuation. When we see its policies we will be able to compare one with the Labor policy and I suspect it is going to be an election about savings and how they should be taxed and treated. 

Of course the Coalition promised not to substantially change superannuation, so if it does attack superannuation it will be a clear breach of its undertakings to the electorate.