We enjoy holding regular “open mic” sessions where our clients have the chance to ask us any questions that are top of mind – whether it’s about the economy, changes in legislation or current issues – like the implications of the Royal Commission for portfolios.
Here we share the key insights from this dynamic Q&A. We hope you enjoy it!
1. What is the likely impact of the Royal Commission on bank share prices?
This is an important question – as the banks and related financial companies comprise approximately one-third of the Australian share market. For a balanced super fund, that could mean an exposure to the local financial sector of around 8 percent of its total portfolio.
While the Royal Commission into Banks and Financial Services has put a short term dampener on this sector of the market, the long term impact on the bank’s fundamentals and their share prices is likely to be minimal.
Here are four reasons why:
- The major banks have wide economic moats – that is, a position of strong competitive advantage which they are likely to maintain.
- While the banks’ financial planning businesses have taken a thrashing, the wealth businesses are not large profit contributors for the major banks – and in fact, the financial planning arm is often a cost centre. The main part of the bank’s businesses – the ‘cash cow’ – is mortgages.
- For the major banks many of the issues and allegations of misconduct raised in the Royal Commission have already been dealt with or are in the process of being dealt with – including hundreds of millions of compensation payments to clients.
- While the banks’ financial planning businesses have taken a thrashing, the wealth businesses are not large profit contributors for the major banks.
- Further, it is likely that we’ll see an acceleration of the major banks downsizing, divesting and reducing emphasis on financial planning. ANZ is already in the process of selling its wealth management arm, CBA has announced the spin-off of its Colonial First State wealth business and NAB has recently announced the sale of MLC.
- The banks hold high credit-quality loan assets – we don’t have non-recourse loans in Australia – and have a diversified funding base.
We should note that we are not suggesting that bank stocks won’t weaken at all – they could. Plus, there are many other pressures on the banks beyond the Royal Commission that could cause share price weakness. We only need to look at global volatility; the threat of higher interest rates which may affect borrowing costs and margins; and of course, the trade tensions increasing between the US and China.
2. What changes are likely to happen in financial planning?
We are anticipating significant changes in this sector as a result of the Royal Commission.
As painful as the process is likely to be, we believe that the final result is likely to be positive, both for clients and for financial advice as an emerging profession.
Here are some of the key changes we anticipate:
- Splitting of the product business from the advice business. The current vertically integrated model – where advice is a “distribution” arm of the product provider – is not sustainable for financial advice as a profession.
- Many dealer groups (that is, groups of advisers) who, though not branded the same as the banks, are aligned with them through distribution agreements, will either be sold, or shut down.
- The banks will exit the wealth management space – which we’re already seeing underway.
- More stringent education requirements for advisers new will cause financial advisers to exit the industry. There are around 23,000 financial advisers in the industry currently – and it is predicted that as many as 8,000 advisers could leave.
- With the departure of advisers and loss of product revenue, it will be hard for many product-based firms to stay in business. It is expected that there will be over-supply of practices for sale.
- Licensees (the firms who provide advisers with authority to offer advice) will be thinking a lot harder about to whom they give that authority.
- It will be vital for any advice firm with its own licence to commit significant resources to governance and client management, including aspects such as data management, technology and platforms, and audit.
- As a consumer, it is likely that there may be fewer choices in the short term.
- In the medium to longer term, we should see more “robo” advice – where individuals can access AI-enabled tools to assist with basic investment decisions. We see this increased access as a positive – with more people able to access investment decision making tools.
In summary, we see the positives as moving towards professionalism, with advice being valued for truly helping people make financial choices to help live a better life.
3. Trump, tariffs and the global economy – what’s happening?
While the tariff tit-for-tat appears to be random and reactive, Westpac’s head of financial market strategy Robert Rennie argues that this is far from the truth.
Rennie argues that Trump is using very specific powers in a highly planned and preemptive way to move from “free” trade to what the US administration argues should be “fair” trade.
“Trump is the first US President to use section 232 powers to execute tariffs and this speaks to the idea that this administration is willing to get inventive, actually use the significant powers the executive branch has and take a much more aggressive stance in terms of dealing with China.”
These powers enable the US President to impose tariffs in a situation where there is a threat to national security.
If the new tariffs of $200 billion go ahead — on top of the tariffs on $34 billion worth of Chinese goods that have already commenced, and alongside separate tariffs on $16 billion worth of Chinese goods — the total amount of goods subject to tariffs would come to $250 billion.
This would represent about half the value of China’s annual exports to the US. Yet, the Chinese government, after initially reacting angrily, appears to be calmly considering its options. This leads to some hope that China-US trade negotiations aren’t completely off the table.
There were also signs in the past week that Donald Trump may be softening his position, holding a meeting with European Union Commission President Jean-Claude Juncker where they decided to work together toward zero tariffs.
In terms of implications for Australia, it seems that we may benefit from trade tensions.
Given Australia’s established trade relationships with both the US and China, any attempt by either country to diversify from the other could end up boosting demand for Australian goods. China, for example, could look to buy soybeans from Australia instead of the US.
Westpac’s Rennie also argues that there is another benefit for Australia from China’s attempts to clean up its air. China has in recent years shifted to higher-quality iron ore, leading to less smog from steel production. Australia specialises in exporting the high-grade iron ore that China wants.
4. What are the implications of Brexit for Australia?
It’s hard to say for sure – but it appears to be on the range from neutral to positive.
The British Government is currently working to lay the foundations for Brexit – with the signs being that it will be a “super soft” exit from the European Union.
This is likely to be positive for the UK economy – and for Australia, as it would be a continuation of our existing situation.
It is also important to note that with trade tensions between the US and China – two of Australia’s biggest trading partners – Australia is actively seeking to secure free trade agreements for itself.
Trade minister, Steve Ciobo, has recently been in London to hold discussions on a potential post-Brexit free trade agreement with the UK. Australia is also in the early stages of free trade negotiations with the European Union.
5. What are your expectations for the RBA cash rate?
Very boring. The consensus amongst most economists is that there will not be a rate increase in 2018, 2019 nor possibly in 2020.
It is important to remember that the cash rate is not the same as mortgage rates. We are seeing increases in the cost for the banks to provide funds for lending. This is likely to result in out of cycle rate hikes from the major banks.
Remember, no matter how seemingly big the crisis of the day, the market will quickly react. By the time news reaches you, it’s likely the market’s flux has come and gone – and markets have moved on to worrying about something else.
As Nobel-winning economist Paul Samuelson says: “Investing should be more like watching paint dry… If you want excitement, take $800 and go to Las Vegas.”
Our key message: don’t let the latest news affect your wise investing behaviour.