Reserve Bank and election guarantee an unsettling time for investors
The ReserveBank isn't calming the nerves of investors going through typical electionyear anxieties, writes Daryl Dixon.
By highlighting the increasedrisk for both investors and the banking system of an oversupply of apartmentsand commercial real estate, the Reserve Bank has added to the normaluncertainty facing investors inan election year. Not only would a collapse in apartment prices be bad news forheavily geared investors and the property market generally but also it wouldadversely affect the share market via downward pressure to banking profits.
Share investors have beenreducing their exposure to banking shares over the past year largely as aresult of the regulator's tightening of capital requirements. But even attoday's lower weightings, bank shares account for about 20 per cent in themajor indices. Even when investors have no direct exposure to bank shares,millions of investors have significant exposure to the banking sector in theirsuperannuation and index-based managed funds and exchange-traded funds (ETFs).
While the share market hasbeen currently boosted by the partial recovery of commodity prices, a more than10 per cent increase in the dollar's value has reduced the benefit toshareholders of resources shares. Overall, where the market goes from here maywell depend upon the future strength of the dollar.
Both the share and propertymarkets would benefit from a lower dollar because of the lower cost ofAustralian assets for overseas investors particularly those from China. Giventhat it would still be some time before a deteriorating government budgetarysituation reduces our AAA credit rating, the possibility of Reserve Bank actionto reduce the short term official rate below the current 2 per cent is themajor hope for the dollar to move lower.
Institutional investors havebeen taking advantage of the higher dollar to increase their asset weightingsin overseas assets. Investing overseas is generally a more difficult exercisefor individual investors who are confined largely to unlisted managed funds orlisted ETFs.
Despite this drawback,diversifying portfolios by increasing unhedged holdings of overseas assetsoffers the opportunity to profit from a lower dollar in the future. There canbe no certainty that the dollar will fall to lower levels if the commodityprice increase continues but owning overseas assets reduces the risks ofinvesting solely in Australian assets.
During periods of uncertainty,one investment option continues to be attractive: to reduce outstanding debt.Doing so reduces the risk of being forced to sell assets while markets aredepressed. Having no or lower debt levels also increases the ability to takeadvantage of market falls in situations such as those being contemplated by theReserve Bank in apartment markets in major locations.
Reducing gearing levels willincrease income tax payable but it still generates additional after-tax incomewhile allowing investors to sleep at night.