Trump stays mum on tax cut details

Whether we like him or hate him US President Donald Trump is in the process of changing the investment world as we have known it for the last decade. All Eureka Report readers need to be aware of this. What is less certain is the timing of the change.  

The failure of the US President to make specific, detailed pledges on the key issues affecting markets – such as tax – indicates it may take longer than the markets anticipated. So don't be surprised if we have volatility.

But the President made it very clear that he is looking for an America where companies pay a lot less tax; the middle class pays a lot less tax; more people enter the middle class; middle class incomes rise; and there is a substantial increase in expenditure on defence. In addition, a big chunk of this will be paid via tariffs on imports or tax structures that stops deductibility on expenditure of imports. But the deficit will rise sharply.

The bottom line of all these things is higher inflation and higher interest rates, and those higher rates will spread around the world including Australia. Investment strategies based on very low rates will be put in jeopardy. It will take time to happen but eventually it may affect our housing market. 

America is going to spend $US1 trillion on infrastructure, but it will take time to develop the projects. It is going to need a lot of iron ore pellets and gas and oil.

China will have to change its direction and to the extent that Australia relies on the old China strategy, we too will need to change.  

But there is a good chance that the looming American boom will actually infect the world and, if that happens, our commodities will improve in price. If I had to guess I believe that oil will do better than iron ore.

OPEC delivering

While President Trump was preparing to deliver his address there were some fascinating statistics in the oil market. 

For months now old-time oil observers have been very doubtful as to whether the proposed OPEC production cuts would be realised. They did not appreciate that last year's production agreements were co-ordinated by none other than Saudi Arabia and Russian President Vladimir Putin. As a result, those production cuts are really starting to work and in the next few months it looks like the oil price will firm. In simple terms, 2017 is expected to see oil demand growth of around 1.5 million barrels per day.  

It could be higher, particularly if the United States' economy gathers momentum on the back of President Trump's policies. The OPEC production cuts take off about a further 1 million barrels per day – a total shortfall of, say, 2.5 million barrels per day. In addition non-OPEC countries outside the US will push the shortfall even higher – perhaps to 3 million barrels a day. 

Offsetting that shortfall will be the Trump-inspired US oil production increases. Even the most optimistic of forward predictions of US oil output mean that they will struggle to fill half the gap. In 2018-19 production may be a lot higher – but that is down the track.  

Russia and Saudi Arabia really wanted a higher oil price because both countries were bleeding in the wake of the production excesses which were driving down the price. Obviously, any predictions on oil prices are fraught with danger but we are starting to see the end of the enormous Islamic State turmoil in the Middle East and, out of that turmoil, Russia looks to be one of the most powerful countries in the region. They are desperate for higher prices.

If the oil price does start to edge up it is great news for Australia's liquid natural gas exporters because their production prices are closely tied to the oil price.

Unfortunately, in Australia we have a shortage of gas which is being created by government policies in Victoria and NSW and the fact that, among the Gladstone LNG producers, the Origin and Santos consortiums have sold gas they do not have in Queensland. They therefore suck gas from the Cooper Basin and Bass Strait by paying whatever price is required. Accordingly, the higher oil price means that those businesses in Sydney and Melbourne who are big users of gas will have much higher costs – so in your portfolio keep an eye on stocks that are vulnerable to this situation. 

Packer back

And on a somewhat lighter note, when you are investing in a company where the ownership is dominated by a particular family, be watchful if that family suddenly appears in the social page headlines. 

Crown Resorts is a good example of such a phenomena. James Packer and the family own just under 50 per cent of Crown. We watched James sell a small slab of his equity in Crown to fund a family settlement. On its own that was fine, but James found himself in the social page headlines with all sorts of affairs and controversies.

Much of the material was inaccurate but it meant that James took his eye off the ball. Furthermore, Crown itself was a very profitable business and, like all profitable businesses, often costs rise in the good times. In particular Crown did not spend enough time studying the government regulation changes in its base consumer market – high roller Chinese gamblers. 

As a result a number of its executives are now in custody for allegedly planning to entice Chinese gamblers to high roll in Australia. I am not going into the rights and wrongs of what Crown did but it needed to be very, very attuned to what was happening in mainland China to avoid that sort of risk. 

But James has now sorted out his social affairs and, in particular, brought into Crown management the man who has been his strategic advisor for a long time – John Alexander. John Alexander helped James Packer get clear of the media business before the industry hit hard times. It was a brilliant sale. He also has a fantastic eye for costs that can be eliminated, and that is what he is doing at Crown.  

Not surprisingly the Crown chief executive thought it better to step aside. Crown is heavily involved in a major development in Sydney to attract Chinese high rollers. It will be hoping that the Chinese relax the rules. It is also looking at a massive new development in Melbourne, although that appears to be based on middle-class Chinese visiting Australia and where gambling is merely a side issue. That is a lot safer market.  

Crown has a lot of issues to tackle but the good news is that Packer and Alexander are back.