Equity strategy: Federal Budget 2022/23
About the author:
- Author name:
- By Andrew Tang
- Job title:
- Analyst - Equity Strategy
- Date posted:
- 30 March 2022, 10:00 AM
- Sectors Covered:
- Equity Strategy and Quant
As expected, the 2022-23 Budget largely follows the same strategy as those post-COVID, putting aside balance sheet repair in favour of tax relief and fiscal expansion.
Yesterday’s Budget announcements reaffirm the commitment to support the economic recovery and provide a strategy to counter inflation (cost-of-living pressures) through additional spending.
While considerable economic uncertainty exists, the expansionary budget arrives against an inflationary backdrop that could put additional pressure on interest rates.
The previous budget put a spotlight on jobs and the need to bring the unemployment rate down towards 5% before the focus shifts back to fiscal repair. With interest rates trending higher and unemployment now at 4%, this could end a cycle of expansionary budgets.
Unemployment is expected to fall further to 3.75% by next year.
A vastly better fiscal position due to a perfect storm of strong employment growth and commodity prices has given a margin of safety for the government to dial-up spending. One-off cash payments, tax-relief, infrastructure spending and housing form the centrepiece of the government’s plan to support the ongoing recovery.
And given the RBA is looking to trim monetary support, fiscal policy will need to plug the gap if the recovery stutters. Nevertheless, we see the measures announced today as broadly supportive for equity market sentiment.
Economic repair over fiscal repair
Economic repair over fiscal repair – the government continues to prioritise spending over saving. At the headline level, a deficit of A$79.8b is expected in 2021-22 (3.5% of GDP), down from a deficit of A$99.2b (4.5% of GDP) predicted in the 2021-22 MYEFO. Deficits are expected to remain over the forward estimates.
Three core principles guide this year’s budget:
- Firstly, to sustain the ongoing momentum in the economy (targeted fiscal support).
- The second to ease household inflation pressure.
- And the third to build for the future (investment in strategic industries and infrastructure).
While rising debt levels is an outcome of this year’s budget, the capacity for the economy to absorb higher interest repayments is cushioned by low borrowing costs for now (Australian 10-year bond yield at 2.83%) but inflation could pose a problem for debt servicing in future.
Treasury’s forecast for gross debt rises from A$906b in 2021-22 to A$1,169b in 2025-26 (45% of GDP). However Australia’s fiscal position remains in much better shape than global peers. This leaves some dry powder should current economic conditions deteriorate.
World gross debt-to-GDP (Consensus forecasts and Treasury estimates)
Incrementally positive for equity markets
Taking everything into account, income tax relief, cash handouts, housing subsidies and infrastructure spending should reinforce confidence that there is still an appetite for deploying fiscal policy to sustain the rebound in economic growth.
Importantly for the market, the cut in the fuel excise and the one-off cash payments will produce a short-term boost to the economy. We expect some upside to infrastructure-related stocks from the additional commitment to infrastructure spending.
We also see support for the AUD as the fiscal position remains in a stronger position than peers despite the step-up in fiscal spend.
Pulling levers to encourage consumption
One-off cash payments, a cut in the fuel excise, extension of the LMITO, business tax incentives, and housing support are positive signals for consumption. And given the weak appetite for international travel, strong employment market and elevated household savings levels, the pent-up domestic consumption story is likely to remain intact over the next 6-12 months.
Budget assumptions
Key commodity prices are assumed to decline from current elevated levels by the end of the September quarter 2022: the iron ore spot price is assumed to decline from US$134/tonne to US$55/tonne; the metallurgical coal spot price is assumed to decline from US$512/tonne to US$130/tonne; the thermal coal spot price is assumed to decline from US$320/tonne to US$60/tonne FOB; and oil prices (TAPIS) are assumed to decline from US$114/barrel to around US$100/barrel. AUD is expected to remain at 72c through the forecast period.
Our thoughts
The key objective of this year’s budget is to extend the bridge of fiscal support against a rising cost environment for households. Today's announcements reinforce our view that fiscal support will not be withdrawn hastily.
However, the government still lacks the determination to bring about significant structural reform, chiefly around productivity, environment and innovation. The lack of genuine long-term reform has been an unfortunate feature of recent budgets.
In our view, the budget is unlikely to bring about significant revisions to corporate earnings, however the ongoing commitment to support the economic ‘restart’ will underpin market sentiment and support earnings confidence. Housing, Resources, Energy and Financials have benefitted from the bounce back in economic activity and the current inflation dynamics.
Household balance sheets are in great shape which should continue to support the strength in consumption. We also see upside risk to dividends if economic conditions hold, keeping payout ratios elevated. We prefer a targeted portfolio approach favouring quality (strong cashflow and market position) and reflation (Energy, Resources) and tactical reopening beneficiaries (Travel, Ag/Chem, Traditional Retail). See our Best Ideas for our most preferred exposures.
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