By highlighting the increased risk for both investors and the banking system of an oversupply of apartments and commercial real estate, the Reserve Bank has added to the normal uncertainty facing investors in an election year. Not only would a collapse in apartment prices be bad news for heavily geared investors and the property market generally but also it would adversely affect the share market via downward pressure to banking profits.
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Share investors have been reducing their exposure to banking shares over the past year largely as a result of the regulator's tightening of capital requirements. But even at today's lower weightings, bank shares account for about 20 per cent in the major indices. Even when investors have no direct exposure to bank shares, millions of investors have significant exposure to the banking sector in their superannuation and index-based managed funds and exchange-traded funds (ETFs).
While the share market has been currently boosted by the partial recovery of commodity prices, a more than 10 per cent increase in the dollar's value has reduced the benefit to shareholders of resources shares. Overall, where the market goes from here may well depend upon the future strength of the dollar.
Both the share and property markets would benefit from a lower dollar because of the lower cost of Australian assets for overseas investors particularly those from China. Given that it would still be some time before a deteriorating government budgetary situation reduces our AAA credit rating, the possibility of Reserve Bank action to reduce the short term official rate below the current 2 per cent is the major hope for the dollar to move lower.
Institutional investors have been taking advantage of the higher dollar to increase their asset weightings in overseas assets. Investing overseas is generally a more difficult exercise for individual investors who are confined largely to unlisted managed funds or listed ETFs.
Despite this drawback, diversifying portfolios by increasing unhedged holdings of overseas assets offers the opportunity to profit from a lower dollar in the future. There can be no certainty that the dollar will fall to lower levels if the commodity price increase continues but owning overseas assets reduces the risks of investing 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 are depressed. Having no or lower debt levels also increases the ability to take advantage of market falls in situations such as those being contemplated by the Reserve Bank in apartment markets in major locations.
Reducing gearing levels will increase income tax payable but it still generates additional after-tax income while allowing investors to sleep at night.
Daryl Dixon is the executive chairman of Dixon Advisory. comments@dixon.com.au
