Super funds and private investors now face the prospect of increasingly volatile markets because of the heightened tensions between North Korea and the US and also because of the Commonwealth Bank's major compliance problems.
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While the CBA's regulatory problems aren't a key factor on the world scene, domestically the impact could be significant because leading bank shares are an important component of the share market and widely held by investors large and small.
Bank share prices were already coming under pressure because of regulator APRA's tightening of lending requirements and a softening property market. The Reserve Bank has now ruled out the possibility of further interest rate reductions because of the recent strength in the Australian dollar and a steadily performing economy.
It could take some time to rebuild public and investor confidence in the operation of our major banks even if the CBA escapes meaningful penalties for its regulatory breaches. The remaining attractions of owning bank shares are the high fully franked dividend yields which will help put a floor under price falls as long as earnings continue to hold up.
The North Korean tensions are a totally different and more worrying concern. The impact of any outbreak in hostility on world share markets is completely uncertain but is most unlikely to be positive. With US markets at record or near record highs, the risk of a steep fall is high.
Given the large exposure of US and foreign investors to US assets, the adverse impact on current investor returns could be significant. The initial impact of the Gulf War in the early 1990s on markets was negative but was then followed by years of solid returns for investors.
The key factor will be the size and scope of any conflict to come. Currently markets in countries close to North Korea are coming under selling pressure with very little impact on the US and Australian markets.
In Australia, a crucial issue in any conflict would be whether our main trading partner, China, becomes involved. With such a high level of uncertainty about how and what could happen, the challenge for investors is to ensure that their portfolios have a risk profile they are comfortable with when substantial problems arise.
The best time to take profits or rebalance portfolios is when markets are performing well. Despite the higher yields available on more risky assets such as property and shares, cash can be king if markets are likely to fall.
Among the many factors affecting investment risks, the level of gearing and diversity of asset holdings are paramount. With the higher level of uncertainty now emerging, reducing debt levels and overweight holdings of assets are options to consider.
Daryl Dixon is the executive chairman of Dixon Advisory. comments@dixon.com.au
