Decisions, decisions

The extraordinary non-outcome of the Federal election creates significant uncertainty for the Australian market. The balance of power now rests with a small handful of independent MPs who will horse-trade their way to extracting a major rural dividend for their individual electorates.

“If the cost of winning the Treasury benches means pork-barrelling a handful of rural electorates, then the country could probably afford to tolerate such tactics”

It’s just as important to note that the balance of power in the Senate will shift from a different collection of independents to the Green Party from July 2011. This factor will leave open a window of opportunity for whoever forms the government to manipulate the situation before facing an entirely different set of compromises when the changeover occurs next year.

For now, we are assuming that another election will not have to be held. This implies that either the Labour Party or the Liberal-National Coalition will be able to successfully woo the independent MPs with sufficient candy-bar politics to form a minority government. It is certainly not in the interests of the independents to return to the ballot as they already have the aces they need.

It is as if the independents have done a ‘Stephen Bradbury’ and come from behind the main contenders who have fallen at the final turn.

It defies common sense that such a minority government would be seen as a stable government and this factor may lift the risk associated with the Australian market for some time.

In our view, the negotiations with the independents will boil down to offering sufficient enticements to each MP’s electorate to draw support to form a government. If the cost of winning the Treasury benches means pork-barrelling a handful of rural electorates, then the country could probably afford to tolerate such tactics.

But it is clearly not going to be quite so simple. For example, the Member for O’Connor in Western Australia is insisting that the Mineral Resources Rent Tax (MRRT) be removed completely in order to gain his confidence. The gun-toting far north Queensland Member is likely to turn up to negotiations with a blank piece of paper, perhaps in search of a blank cheque for the Kennedy electorate. The slightly more cerebral Member for Lyne in northern NSW is talking about reforms to the political process including a better hearing for private Member’s bills. The other independents are yet to reveal their hand, understandably, until negotiations have begun.

Adding to the difficulty of garnering support from this collection of MPs is the fact that each has his own agenda. There is likely to be some commonality among them, but their differences are what will tangle the process.

Making matters even more delicate is the fact that each of these MPs is a disaffected former Member of one or more of the larger parties. There will be grievances and grudges flowing underneath the discussions that could easily de-rail talks and send the process backwards or worse, in the direction of the other major party.

One clear policy difference between Labor and the Coalition is on broadband. The scenario as we know it today has a Labor government building a $43 billion fibre-to-the-home (FTTH) broadband network to 93% of Australian premises with the balance being served by a combination of other technologies. The NBN is expected to take around eight years to complete and is not expected to be commercial enough to attract private investment.

The Coalition broadband policy is to supplement private investment to the tune of $6 billion and utilise a greater range of technologies to achieve the same coverage across Australia.

Without delving into the finer points of each plan, it does seem as though the Coalition’s might suit the mainly rural and regional independent MPs much better. Mobile and other wireless technologies could reach these communities much more quickly and cost-effectively than Labor’s FTTH plan.

In effect, the Coalition’s plan could build a national broadband network from the outside in – from rural Australia first, then urban Australia later. It might be possible to resurrect the $1 billion Regional Broadband Network blueprint that was cancelled by the Labor government.

The MRRT issue is also likely to be more aligned with the Coalition’s thinking. Labor’s policy of using the MRRT proceeds to fund company tax cuts would be scuppered if the MRRT was not enacted. Following a path of encouragement for corporate investment might not only create more direct jobs but also support the rural communities that co-exist with the mining industry.

Tax reform is another area that will swing one way or another depending on the negotiations. This will be particularly significant for small businesses in Australia.

Although the Greens are in favour of a carbon tax, this policy area may prove to be the most contentious amongst all the independents.

But nothing can be taken for granted when the job of Prime Minister is at stake. The independent MPs clearly know this and will use it to their advantage.

It’s probably an automatic decision for investors to simply wait on the sidelines until a government can be formed in Australia.

In the Senate, it becomes even trickier for whichever party can form the government. From 1 July 2011, the Green Party will have 9 seats with which to play kingmaker to any proposed legislation. This platform will become a powerful antidote to the government’s agenda unless it can incorporate the Green’s agenda at the same time. The Greens, for example, are demanding an increase of around $2 billion to the MRRT and an increase in the company tax rate to 33% to fund various projects of their own.

It would not surprise us to see a very limited range of legislation being passed once this change occurs, unless it gets through in a highly diluted manner.

This consensus politics is becoming a feature of several overseas governments but unfortunately does not always deliver the best outcomes. Investment markets again will find this difficult to assimilate as corporate Australia will struggle under the uncertainty.

The latest musings from the Reserve Bank of Australia, however, paint a decidedly rosy picture for investors, notwithstanding the political uncertainty. GDP growth is robustly positive, supported by a 60-year high in the terms of trade and record export volumes of commodities, particularly to Asia. Our Asian trading partners are showing no signs of waning demand for our commodities and indeed are contemplating further direct investment in Australia to secure such supply.

For Australian consumers, despite recent rises in mortgage interest rates, confidence in the economy is distinctly positive even if a degree of spending caution has emerged. The country has one cautious eye on the slowing US and European economic recoveries but probably feels smug in the knowledge that unemployment here is just 5.3%.

For the equities market, that background should underpin the valuations of most companies. The current reporting season is mostly bearing that out with generally good profit results, tempered by the usual moderate outlook statements.

Turning to the charts, the 50% Fibonacci retracement capped the upward move, working in confluence with the psychological 4,600 resistance level. This saw the Parabolic stop executed. The red dots on top of the price is an indication to traders to switch to short. We expect the 23.6% Fibonacci retracement at 4,376.16 to offer firm support, which is likely to be tested this week. A break below this level would commence the beginning of a short term downtrend and a possible test of the 4,175.70 – 4,182.30 support zone.

A bearish ‘head and shoulders’ formation is potentially in play, a break of the neckline would validate this pattern. Should this result, the downside target is towards the May 21 low of 4,175.7. The weakening RSI and negatively crossed MACD are suggestive of near term weakness.

The Dow Jones Industrial Average failed to break above the 200 period moving average (red line) and has since pulled back below the 50 period moving average (green line). In addition, the rejection of the 38.2% Fibonacci retracement level at 10,242 suggests that we are likely to see further weakness. Support is located at the confluence of the 23.6% Fibonacci retracement and psychological 10,000 level.

Gold successfully broke out from the bullish continuation flag pattern to reach a recent high of US$1,237.04 on August 19. We have also seen a break of the RSI downtrend and a positive MACD crossover which has now been confirmed with the bullish move back above the zero signal line.

The almost vertical appreciation in price should now lead to a period of consolidation. We would expect support to hold at the 50 period moving average (green line) at US$1,209. Once the short term corrective phase is complete, we would anticipate a move higher in line with the broader term uptrend. The upside target is towards the June 21 high of US$1,265.