Insights

Last week, I discussed how Trump was using tariffs in economic policy. I explained that the administration aims to pass a significant, comprehensive bill : an omnibus bill, which includes the Reciprocal Trade Act;  reduces the corporate tax rate to 15%, and imposes a 10%revenue tariff by April. I also showed that, despite commentary to the contrary, this tariff revenue was not inflationary, contributing a maximum of 0.8% to the US Consumer Price Index (CPI). 

However, this week what we've seen is that Trump has used tariffs not for economic purposes but rather for social policy, in attempting to address the social crisis in the United States.  This social crisis  helps explain much of how Trump was elected and why he now has substantial support.

This situation began in 2000 when China entered the World Trade Organization, which allowed its exports to enter the US market. At the time, tariffs were very low, around 1–2%.

Over the next decade, the US experienced deindustrialisation. 12 million American workers losing their jobs, and never got them back. This created a significant social crisis in the US, contributing to a social collapse . This collapse led to a massive increase in drug dependency, particularly within the American working class. A key work on this issue was written by Nobel Prize winners, Sir Angus Deaton and his wife Anne Case  in 2020, titled Deaths of Despair. 

In the book, Deaton points out that the US overdose deathrate increased from under 20,000 before 2001 to  92,000  in 2020. Overdose deaths rose further to 108,000annually by 2024. Notably, young men are twice as likely to die from these drug overdoses as young women.

Peter Navarro, Senior Counsel Trade and Manufacturing  in the Trump administration, made his career at Harvard researching American trade with China. He claims that 76,000 of those drug deaths are directly linked to fentanyl use. From a social policy perspective, Trump's recent actions, including threatening to impose a 25% tariff on Mexico and Canada within a month and introducing a 10% tariff on China, reflect a shift towards addressing the flow of fentanyl into the US. This is not simply a trade war but, as Navarro asserts, a "drug war" aimed at reducing the influx of fentanyl and fentanyl-laced drugs.

In response to these threats, Canada has pledged $1.3 billion to police its border, and Mexico has committed 10,000 troops to patrol its border. I would bet that no 25% tariffs will be imposed on Mexico and Canada in fact, I am highly confident of this. Fentanyl, which is involved in the majority of drug-related deaths, primarily originates from Mexico and is produced with chemicals from China. The 10% tariff on China could be a precursor to a similar revenue tariff later in the year as part of the omnibus bill. Remember, Biden before he left office, already levied a 100% tariff on Imports of Chinese Electric Vehicles into the US.

Historically, during Trump's first term, Trump  had a meeting with Chinese President Xi Jinping, who promised to reduce the flow of basic chemicals to Mexico that were used to produce fentanyl. However, in response to the latest 10% tariff, China has stated that "fentanyl is a US problem "and has declined to cooperate as it had promised in the past.

The key question now is whether US tariffs on China will harm  Australian exports to China.  Australia's Iron Ore Exports to China are valued at $84 billion annually. China's steel Industry is the  largest in the world.  Will US Tariffs on China  damage Chinese steel exports? When we examined Chinese exports of steel last year, we found that very little Chinese steel is exported to the US.  According to US data, the majority of Chinese steel is exported to the Indo-Pacific, with Vietnam being the largest importer (at 9.96%), followed by South Korea (9.1%),Thailand(5.3%).the Philippines (5.2%),Indonesia(4.5%), Türkiye (4.4%),The UAE(4.0%) and India (3.2%).  The amount of Chinese steel sent to the US is minuscule. Therefore, it is difficult to see how any US tariff on Chinese steel would have a significant impact on Australian exports to China.

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February Reporting Season 2025 has kicked off. The February reporting season offers a crucial window into corporate Australia's health, with company-specific performance taking precedence over macro considerations. While earnings and share prices have shown remarkable resilience since the August reporting period, the focus shifts to companies' ability to maintain margins and drive growth amid subdued trading conditions, particularly as earnings growth moderates in FY25.

With a modest earnings outlook companies have been forced to adapt to the softer trading environment. Our focus in February is on companies and sectors that continue to see margin resilience and positive earnings trends. Large caps is another area to monitor given historically high valuations and strong performance over the past 12 months. Last August demonstrated that high expectations and in-line results might not be enough. The recent swing in the AUD will also complicate FY25 earnings and those exposed to currency fluctuation could see earnings volatility around the result.

In The Month Ahead this month, we highlight three companies from our key results to watch: Pinnacle Investment Management (PNI), Superloop (SLC) and Lovisa (LOV).

Pinnacle Investment Management (PNI)

RESULT: 5 FEBRUARY 2025

We expect outperformance driven by performance fees

We expect a strong result from PNI, driven by a combination of higher FUM through the period and strong performance fee contribution. We expect PNI can outperform consensus expectations based on higher performance fees. Key numbers include underlying 1H25 NPAT (forecast +105% on pcp to A$61.9m); and affiliate profit share (forecast +82% on pcp to A$68.1m).

Core flows and leveraging Horizon 2 spend

Current momentum and the outlook for flows is always in focus. We expect confident commentary from PNI, in part supported by new affiliates (e.g. Lifecycle). Horizon 2 spend has ramped up in recent years (primary driven by Metrics) and the market will be looking for some commentary or evidence that returns are starting to materialise.

Cashed up and ready

PNI has ample ‘dry powder’ following an equity raise in Nov-24. Commentary on the early performance of recently acquired stakes and the pipeline will be in focus.

Superloop (SLC)

RESULT: 21 FEBRUARY 2025

FY25 outlook

SLC expects FY25 underlying EBITDA of $83–88 million. We estimate $35.8 million for 1H25 (41% of full-year earnings), slightly below market consensus of $38 million (as of Jan 17, 2025). Since guidance was set in Feb 2024, there’s potential upside. One-off $5.5 million expenses in 1H25 include legal fees from ABB’s failed takeover and costs for acquiring Optus/Uecomm fibre assets (finalising by Mar 2025). A Vostronet earnout will also impact cash flow. Despite this, we expect net debt to decline slightly.

NBN subscribers (organically and Origin originated)

We forecast SLC will deliver slightly fewer NBN net adds in 1H25 (+31k yoy to 354k) vs +33k yoy in 1H24. This is due to our assumption that SLC has prioritised the material Origin migration. This assumption could prove conservative. Origin is, by our maths, the largest single EBITDA driver in FY25. We expect Origin to have ~155k NBN subscribers at year end, noting some of the Origin labelled ‘subscribers’ include voice products which SLC does not provide. We also assume organic growth in Origin is relatively slow in 1H25 due to the migration from ABB onto SLC. This should hopefully re-accelerate above its historical ~4.5k monthly net adds in early 2H25, although this is not within SLC’s control.

Business

The business segment remains challenged (NBN/macro driven price erosion), but we should still see some growth and are optimistic competition should settle in the latter half of CY25. We await clarification on the industrial logic around the Optus fibre acquisition which is likely largely back-haul cost avoidance for Smart Commmunities, and also provides SLC with the ability to more efficiently bring to market new product innovations (revenue upside).

Lovisa (LOV)

RESULT: 24 FEBRUARY 2025

Double-digit growth in earnings to continue

We see Lovisa’s half year result as an opportunity for it to remind investors of the growth in earnings it continues to deliver. We forecast a double-digit increase in revenue and income, all organic, driven by ongoing network expansion and higher gross margins. Our EBIT forecast of $93.1m is largely in line with consensus and represents 14% growth on 1H24. We forecast LFL sales of +1%. We expect the store count to have risen to 939, a net increase of 39 over the half, including 12 since the AGM trading update. This is clearly below the rate of expansion achieved in recent periods but maintains the positive long-term trend. We forecast a further increase in the gross margin to 81.5%. Lovisa’s results have seen some wild share price reactions in the recent year. We don’t expect a repeat in February, but the combination of a high P/E and high growth forecasts is always a potent mix.

The pace of expansion is due to accelerate

The key theme in the result will be the sluggishness of recent store rollout activity. The net addition of 39 stores we forecast for 1H25 falls 26% short of 1H24 and 55% below 1H23. In fact, if our number is right (and we are in line with consensus), it will be the slowest half year for network expansion since 1H21. Investors are justified in asking what’s going on. A key reason, in our view, is the need for Lovisa to consolidate after an extended period of very rapid growth in the US. The other reason is more nuanced. Lovisa has entered a large number of brand-new markets in the past two years. Its modus operandi is to spend around 24-36 months in any new market to become familiar with customers, landlords, competitors and price points before proceeding to expand. If we’re right, this is the calm before the storm and the pace of growth is about to get a whole lot faster.

We think it gets better from here

We think 2H25 will be a better (relative) period than 1H25. We forecast 63 net new store openings in the second half, with LFL sales growth picking up to +3%, despite comps getting more difficult. Earnings are always weighted to the first half (Christmas, BFCM and all that) but the 61/39 skew we forecast for FY25 tilts more to the second half than in any year since FY22.

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In recent weeks, there has been much discussion about the inflationary effect of Trump tariffs. This is sparked by Donald J. Trump's proposal of a 10% revenue tariff. Interestingly, the idea of a 10% revenue tariff was first discussed during his first term. At that time, it was considered as a potential source of additional revenue to offset the Trump tax cuts enacted during his first term.

The challenge in passing finance bills in the U.S. lies in the legislative process. Finance bills can only be easily passed if they are reconciliation bills, meaning they have no effect on the budget balance. When a finance bill does not affect the budget balance, it requires only a simple majority in the U.S. Senate to pass. However, when a finance bill increases the budget deficit, it requires at least 60-votes in the Senate, making such bills much harder to pass.

During Trump's first term, the administration found that by reducing certain tax write offs or tax cuts for specific states, they could pass the overall tax bill without effecting the budget balance. This allowed significant tax cuts for individuals and a major corporate tax cut, reducing the U.S. corporate tax rate from 35% to 21%. Now, as Trump seeks to cut corporate taxes again—this time from 21% to 15%, matching the German corporate tax rate—he needs additional revenue to balance the bill. This is so he can pass it as a reconciliation bill, requiring only 51 Senate votes. This has led to renewed discussions about the 10% revenue tariff.

In contrast to the European Union, where a value-added tax (VAT) would be a straightforward solution, implementing a VAT in the U.S. is effectively impossible due to constitutional constraints. A VAT would require unanimous agreement from all states. This is impossible in practise. So, the idea of a 10% revenue tariff has resurfaced.

Critics, particularly within the Democratic Party, have argued that such a tariff would be highly inflationary. However, when questioned during confirmation hearings, Trump's Treasury secretary nominee, Scott Bessent, referencing optimal tariff theory, explained that a 10% revenue tariff would increase the U.S. dollar exchange rate by 4%. We note that this would result in a maximum inflationary effect of 6% only if 100% of domestic goods were imported. Given that only 13% of domestic goods are imported, the actual inflationary impact would be just 0.8% on the Consumer Price Index (CPI). This makes the tariff effectively inflation neutral.

This idea was discussed by a panel of distinguished economists at the American Economic Association Convention in January, including Jason Furman, Christy Romer, Ben Bernanke, and John Cochrane. Cochrane noted that historical instances of tariff increases, such as in the 1890s and 1930s, did not lead to inflation because monetary policy was tight. He argued that the inflationary impact of tariffs depends entirely on the Federal Reserve's monetary policy. If the Fed maintains a firm stance, there would be no inflationary effect.

Trump's current plan is to pass a comprehensive bill that includes the Reciprocal Trade Act, corporate tax cuts, and the 10% revenue tariff. Peter Navarro, in a CNBC interview on 21 January, estimated that the revenue tariff could generate between $US350and$US400 billion, offsetting the cost of the tax cuts and making the bill feasible as a reconciliation measure.

With the Republican Party holding enough Senate seats, the legislation could pass by the end of April. The inflationary impact of the tariff, estimated at 0.8%, can be easily managed through moderately tight monetary policy by the Federal Reserve.

Morgans clients receive access to detailed market analysis and insights, provided by our award-winning research team. Begin your journey with Morgans today to view the exclusive coverage.

Today, I want to discuss the challenges the Reserve Bank of Australia (RBA) faces in cutting rates. To do this, I’ll explore our model of Australian short-term interest rates, and how its components interact. A key focus will be the relationship between inflation and unemployment, and how this relationship makes it particularly difficult for the RBA to now lower rates.

Our model of the Australian cash rate is robust, explaining just under 90% of the monthly variation in the cash rate since the 1990s, when the cash rate was first introduced. The model’s components include core inflation (not headline inflation), unemployment, and inflation expectations.

Interestingly, statistical tests show that unemployment is even more important than inflation when it comes to predicting what the RBA will do with the cash rate. This is because of the strong, leading relationship between Australian unemployment and core inflation.

To illustrate this, I’ve used data from the past ten years up until December, which shows the relationship between unemployment and inflation in Australia. The data reveals a Phillips curve, where inflation tends to fall as unemployment rises. This relationship begins to work appears almost immediately, though there is a slight delay of about 3 to 4 months before its full effect is felt.

We look at the data from 2014 to the end of 2024. When unemployment is around 4%—which is where it has been for the past few months—we can predict that core inflation should be around 3.7%. Currently, core inflation is 3.5%, which aligns closely with what we would expect given the unemployment rate. This suggests that the current level of inflation is consistent with current unemployment levels.

Unemployment vs Inflation

2014 to 2024

However, the RBA’s target inflation rate is between 2 and 3%, with a specific target of 2.5%. To achieve this target, unemployment would need to rise from its current level of 4% to around 4.6% or 4.7%. Historical data, such as from 2021, shows that with an unemployment rate of around 4.6%, inflation can be brought down to 2.5%. Therefore, to reduce inflation to the RBA’s target, the unemployment rate would need to increase slightly—though not drastically. If unemployment were allowed to rise to around 4.6%, it would create enough excess capacity in the economy to put downward pressure on inflation, which would take about 3 to 4 months to materialise.

If the RBA were able to allow this rise in unemployment, inflation would decrease to around 2.5%, and the RBA could cut rates. Current rates are at 4.35%, and under this scenario, we could expect them to drop to the low 3.0% range perhaps even lower. This would represent a fall of around 100 basis points from current levels.

Unfortunately, the situation is complicated by fiscal policy. The current Treasurer, Jim Chalmers, has been expanding employment in sectors like the National Disability Insurance Scheme (NDIS) and other areas of the public service. This fiscal stimulus is preventing unemployment from rising to the level needed for inflation to fall. As a result, unemployment remains stuck at around 4%, and inflation remains too high for the RBA to cut rates.

In terms of job vacancies and other labour market indicators, we would have expected unemployment to rise higher by now. However, Treasurer Chalmers is committed to keeping unemployment low ahead of the election, which is why we find ourselves in this position.

The government’s fiscal policy, aimed at maintaining a low unemployment rate, is preventing the necessary adjustment to bring inflation down.

If I input the current levels of inflation, unemployment, and inflation expectations into our model, the estimated cash rate should be 4.45%. This is 10 basis points higher than the current cash rate of 4.35%.

The Australian Government seems intent on maintaining the unemployment rate at 4% ahead of the election. If it does so, Inflation will remain too high for the RBA to cut rates.

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Following the release of the Aged Care Taskforce report earlier this year, the federal government has recommended a number of changes to the cost of residential aged care, some will commence from the beginning of 2025 and the remainder expected to commence from 1 July 2025.

Over the next 40 years, the number of people over 65 is expected to at least double and the number of people over 85 expected to triple. A significant amount needs to be invested in the Aged Care sector, by both government and private sector, to be able to manage the growing numbers of older people needing care and support in their later years.

From 1 January 2025:

• Increasing the refundable accommodation deposit (RAD) maximum amount without approval from $550,000 to $750,000. This amount will be indexed annually.

From 1 July 2025:

• Introduce a RAD retention amount of 2% pa to a maximum of 10% over 5 years.
• Removing the annual fee caps and increasing the lifetime fee caps to $130,000 or 4 years, whichever occurs first.
• Introducing a means-tested hotelling supplement of $12.55 per day which is to be indexed.
• Removing the means tested fee and replacing it with a means tested non-clinical care contribution (NCCC). The daily maximum is $101.16 which is to be indexed.

From 2029/30:

• The government is looking to commence a phase out RAD altogether by 2035. A commission will be established to independently review the sector in readiness.

Grandfathering arrangements will protect anyone who enters care prior to 1 July 2025 under the “no worse off” principle to ensure they do not pay more for their care.

Comparison of current and new aged care costs

Current aged care fees

The Basic Daily fee continues to be paid by all residents without change.

The Hotelling Supplement is paid by residents as a contribution towards their living costs. It is a means tested payment calculated at 7.8% of assets greater than $238k or 50% of income over $95,400 (or a combination of both). The Hotelling Supplement is capped at $12.55 per day (indexed).

The Non-Clinical Care Contribution (NCCC) replaces the current means tested fee. The NCCC is a contribution towards the cost of non-clinical care services which will be capped at $101.16 per day (indexed). It is a means tested fee calculated at 7.8% of assets over $501,981 or 50% of income over $131,279 (or a combination of both).

The lifetime cap for the NCCC is increasing to $130,000 or 4 years, whichever occurs first, indexed twice per year. There is no longer an annual cap.

Any contributions made under the home support program prior to entering residential aged care will count towards the NCCC cap.

Who will likely pay more from 1 July 2025?

It is expected that at least 50% of people entering care will pay more for their care each year.

The below chart illustrates the expected changes for regular care costs (excluding accommodation costs and retention amounts) for individuals based on specific asset levels:

Should you enter residential aged care before 1 July 2025?

It depends. For some people, if they have an ACAT assessment and are eligible to enter residential aged care, then it would be best to seek advice from your Morgans Adviser on both the current and future cost as well as cash flow and cost funding advice.

Contact your Morgans adviser today to schedule an aged care advice appointment. Our expert team will be able to simplify the aged care system, guide you through Government subsidies, analyse payment options, create 5-year cash flow projections, and model the benefits of home concessions and future asset values for your beneficiaries.

Australian’s life expectancies are increasing over time. We can now expect to live longer - on average 5 to 7 years longer - than our parents or grandparents did.

The problem is that as we live longer, we also need to support ourselves for longer in retirement. This is compounded by the fact that, according to the Australian Bureau of Statistics (ABS), we are retiring earlier these days with the average age of retirement reported to be 56.9 years. Interestingly, the average age people intend to retire is 65.4 years.

According to the ABS’s May 2024 report:

• There were 4.2 million retirees
• The average age at retirement (of all retirees) was 56.9 years
• 130,000 people retired in 2022, with an average age of 64.8 years
• The average age people intend to retire is 65.4 years
• Pension was the main source of income for most retirees

In their Media Release supporting their 2024 retirement report, ABS’s head of labour statistics, Bjorn Jarvis, said: “While the average age people intend to retire has risen over time, it hasn’t changed much in the last 10 years. This average has been between 65.0 and 65.6 years for close to a decade, since 2014-15. On average, men intend to retire slightly later than women, but this gap is closing. In 2022-23, there was around half a year difference between men and women, compared to a year difference a decade ago.”

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Income at retirement

According to the ABS retirement report, a government pension or allowance was still the main source of personal income at retirement for 43% of retirees. This was followed by Superannuation, an annuity or private pension at 27%.

Factors influencing retirement

In 2022-23, the most common factors influencing older workers’ decision to retire was still financial security (36%) and personal health or physical abilities (22%). Around one in eight retirees (14%) said reaching the eligibility age for an age (or service) pension was a key factor.

Retirement planning

According to the ABS, 710,000 people intend to retire in the next 5 years, with 226,000 in the next 2 years. Will you be one of these people? If so, do you have the confidence your retirement plans will be enough to support you in retirement? Your Morgans adviser can review your retirement position and recommend strategies that will help you stay on track so that your retirement, when it happens, is an enjoyable stage of life. Already retired? We can help there too.

Contact your Morgans adviser today to schedule an appointment to discuss your retirement plans.