THE BIG PICTURE: What the election result means for the economy and the markets

As at late on Sunday afternoon, the Australian Electoral Commission noted that the state of play of the parties was ALP 70, Coalition 71, Greens 1, Independents 2 with six seats in doubt. It is likely that there will be three or four Independents. No major party is likely to win power in its own right for the first time since 1940. While the Greens will hold the balance of power in the Senate, this won’t occur until July 2011.

A speaker will need to be appointed – most likely one of the Independents. If the ALP was able to get 74 seats, it may be able to form a workable government with the Greens – not a palatable outcome for financial markets.

Financial markets, investors and business loathe uncertainty. So the election result is clearly undesirable. But it’s not the worst possible outcome. If a major party had to water down its economic credentials to form government, then that would clearly be a negative outcome for markets. And that doesn’t appear the case with three or four well-regarded Independents likely to hold the balance of power.

The Australian dollar is likely to be the major short-term casualty. Investors will trim positions until the election uncertainty is resolved. Certainly it is hard to quantify the impact on the currency – investors haven’t had to deal with election uncertainty since the Aussie dollar was floated in 1983. While the Aussie dollar could lose 1-2 cents in the short term, is will be well supported by Australia’s relatively high interest rates, dependence on the fast-growing Asian economies and the assumption of economic credibility no matter which major party forms a minority government.

Both Labor and the Coalition have worked hard over time to advance their economic credentials, and neither would sacrifice them for short-term political gain. Australians place a high value on economic credibility and would punish any major party that shows slippage on economic and financial issues.

The Labor Party didn’t receive a mandate for major change, so that means measures like the mining tax or the national broadband network are in doubt. But while the mining tax may not proceed, the Independents may be more likely to support the broadband network. But on the same grounds, the Coalition also did not receive a mandate in the election to support major change. The Independents may want the Coalition to incorporate some of the Labor Party’s ideas on increasing internet speed before providing their political support.

Some people believe that a minority Government could be negative for business. In fact it could turn out to be a positive. Any measures that are enacted would have to be well-debated and well thought out. And changes will be hard to come by, meaning that business could see a period of stability over the term of the Government – whatever period that turns out to be.

While a minority Government would be a new concept for Australia, it’s certainly not a new situation for a raft of advanced nations, so foreign investors may actually cope with the situation better than domestic investors.

Sharemarkets, currency & elections

Australian investors have never had to deal with such a close election outcome in the modern era – certainly never one where there was a possibility of a hung Parliament. Our election analysis on July 17 outlined what happened to both the sharemarket and the Aussie dollar at previous polls. The sections below revisit that analysis.

Recap: Sharemarkets & elections

For investors, there is no question that elections are times of uncertainty. But there is no evidence from past polls that Federal election results are unambiguously positive or negative for the sharemarket in the short-term.

In each of the last four Federal elections before the latest poll, the Australian sharemarket was stronger three weeks after the poll date. In the 2007 election (involving a change in government) the All Ordinaries eased by around 3.5% over the three weeks before the poll but then it regained all lost ground after the election result. In fact the sharemarket exhibited a ‘U-shape’.

Interestingly in the previous two elections involving a change in government (1983 and 1996), the sharemarket also basically ended up at the same point three weeks after the election as where it started three weeks before poll date.

The 1972 and 1975 Federal Elections also involved changes of government but the sharemarket on each occasion was stronger in the three weeks after the poll. In the case of the 1972 election, the sharemarket rose by 2.2% and the market lifted 3.8% in the three weeks after the 1975 poll.

Since the 2010 poll was called, the All Ordinaries has lifted 0.6% and the US Dow Jones gained 1.1%. But over the past three weeks, the All Ords has lost 2.1%.

Recap: Australian dollar & elections

Since the Australian dollar was floated in December 1983, there have been nine Federal elections, not including the 2010 poll. The Australian dollar has risen on six occasions and fallen three times in the three weeks after each poll. But on average, the Aussie dollar has appreciated by just less than 1% against the US dollar in the three weeks after elections.

It is important to note that the Australian dollar has appreciated against the greenback following each of the last five Federal Elections, including the 2007 and 1996 polls that involved changes of government. On average, at the last five elections the Australian dollar appreciated 2.3 per cent in the three weeks after the poll date.

Prior to 1996, the last change of government occurred in March 1983 – that is, before the Australian dollar was floated. Interestingly in 1983, ahead of the March 5 poll, there was a significant outflow of capital, as investors grew nervous about the possibility of a change of government. The Reserve Bank estimated that the capital outflow amounted to 3% of money stock or around 1.5 times Australia’s annual GDP.

Following the election – on March 8, 1983 – the Labor Government was forced to devalue the currency by 10 per cent in an attempt to stem the outflow of funds.

In the period since the calling of the 2010 election, the Aussie dollar has risen by 1.6 per cent – from US87.57c to US89c. But in the past three weeks the Aussie has lost 2.2% – similar to the sharemarket.

Implications

Given the possible permutations and combinations, probably the safest place for investors is on the sidelines. We don’t believe that a minority government would necessarily be negative; in fact it could turn out to be positive if greater scrutiny is applied to prospective legislation. Our over-riding concern is that the government that does takes power is not willing to sacrifice Australia’s superior economic credentials.

When Julia Gillard outlined her core priorities on Sunday afternoon, conspicuously absent was the mining tax. The mining tax and national broadband network were the key policy differences between the major parties. The broadband network has the greatest chance of being advanced in a Labor minority government with Independent/Greens support.

Abandonment of the mining tax would be modestly positive for resource company share prices. Still it is always important to remember that this tax has merely been proposed and not enacted. And the start-up date for the mining tax is still some way off – in 2012. So the global economy, China’s economic growth rate and commodity price trends remain the key drivers of resource company valuations.

The outlook for consumer-focused stocks has received a setback from the inconclusive election result. The period of uncertainty and consumer reluctance to spend has potential to last a little longer.

Craig James is chief economist at CommSec.