Be wary of volatility for shares

With the  election over, sharemarket commentators are predicting further share price increases as investor confidence recovers following the change of government. These predictions are in part inspired by past experiences where the election of a Coalition government has been accompanied by a stronger sharemarket.

Whether or not this is the case this time around depends on the performance of our economy and the developments in the Middle East. Both gold and oil prices have moved up with fears of escalation of the Syrian civil war and the prospect of conflict spreading to neighbouring economies.

While investor confidence is a crucial factor, an even more important consideration is the large amount of cash waiting to be invested. With interest rates likely to remain low, the yields from shares, particularly in companies paying fully franked dividends, are still attractive and likely to draw further interest from local investors.

However, the local demand for shares is by itself not sufficient to drive our market higher if, as is a possibility, foreign investors continue to reduce their exposure to Australian markets. Foreign investors own a substantial percentage of our leading companies and have two reasons to continue locking in their profits and repatriating at least part of their holdings.

First and most important is the widely held view that the Australian dollar will continue to fall further as the mining boom ends. Second, the US Federal Reserve has given notice that it will reduce the size of its quantitative easing program aimed at reducing longer-term US interest rates.

This has already caused a repatriation of billions of dollars of US investments in emerging markets and Australia even before any such action has been undertaken. The prospect of a weaker dollar and higher US interest rates will thus have a significant impact on the movement of the sharemarket.

In deciding whether or not to increase share portfolios, individual investors need to be aware of the volatility of sharemarkets over the past decade and the possibility that this could continue.Worldwide, there's a problem in many countries of largely unsolvable continuing budgetary deficits and a forced reliance on stimulatory monetary policy to boost growth.

Even if our newly elected government is able to manage our less serious but still challenging budgetary problems, continued strong performance of the economy will still depend on continuing growth in Asia and recovery in the US. This is a significant reason why share investors need to be prepared for volatility if they choose to increase their share exposure now.  

After all, share prices have increased by about 20per cent over the past year. With the economy slowing, expectations of continuing increases may prove to be over- optimistic.

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