INVESTING

Sharemarket shocks can be a signal to buy

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The impact of a terror attack is to drive fear - uncertainty even - into the hearts of the people at whom it is aimed. In the case of the Paris attacks, it was quite clearly a retaliation for French air strikes against Islamic State, or ISIL, in Syria and Iraq.

The sharemarket reaction is understandable but short-lived. Often the government response to such events lifts an economy and boosts the market in the short term. Extra spending on defence and on rebuilding confidence can be positive - the opposite of what the terrorists sought.

The first major shock that created the long-term war going on in Iraq and Syria was the September 9, 2001, attacks on the US by al-Qaeda. But the 15% fall in the US stockmarket in September was overcome by December. In the case of the July 7, 2005, London bombings, the negative stockmarket impact lasted just one day.

Stockmarket uncertainty

But these attacks are a sharp reminder that confidence shapes business, investment and our overall economy. Without confidence, jobs won't be created and risks won't be taken on investment. Terror groups, including ISIL, are aware of this. It is rumoured that they have often engaged in financial markets ahead of such attacks, to benefit financially from the ultimate in inside information.

In Australia right now, there is plenty of evidence that confidence is rebuilding after the tailing-off of the mining investment boom. The fall in the dollar and record low interest rates have delivered enough stimulus to turn around the competitiveness of many service and manufacturing businesses.

Though it takes time to restore confidence to the point that investments are made and more staff are hired, you can now see this slowly coming through in our official numbers. The stockmarket will pick up on these early signs and, if there is belief in longer-term profitability, share prices will respond.

But there is fear about our banks' dividends (and their profit growth for the next few years) and the stockmarket index has been falling. This has been exaggerated by the mining disaster in Brazil that has damaged BHP Billiton's share price and, perhaps, its reputation.

And this is where your confidence comes in. If you are confident - in the face of a mining disaster and an attack on its reputation - that BHP's management can harness the collective strength of some of the world's best mining assets, you will buy its shares. If you lack confidence, you will not buy. The issue here is more timing than whether you are buying something cheap. BHP shares have been sitting at 10-year lows in recent weeks and are clearly cheap. The bigger question is will get cheaper and, if so, will you care?

The banks have also been under fire because of the requirement to hold more capital to back their loan books and their overall assets. There are two issues here. One was a recommendation from the financial system inquiry that big banks should hold more capital against their mortgage books to replicate the requirements of smaller banks, credit unions and building societies. The other issue is about banks having sufficient capital to make certain they do not collapse in extreme circumstances (such as the GFC).

The problem for the investor is that if you have more capital and less debt, you have to generate even higher earnings to maintain your return on capital - key for investment performance. This was the justification for banks raising their mortgage rates soon after the rules were introduced.

The banks might have to raise even more capital to place them in the world's top 25% of well-capitalised banks (and make them impervious to the most adverse conditions). But if they raise more capital, there will be questions about whether they can increase profits sufficiently to maintain dividend growth.

Again a part of this is all speculation. Nobody quite knows how much capital the big banks might have to raise. Few are certain about how the banks' profits will respond to the slowdown in property investment lending.

But go back to the beginning. If the crisis of confidence after the Paris attacks does not turn into a full-blown panic and if the low dollar and interest rates boost Australian tourism, service and export businesses even further, then the current turbulent period is an opportunity for buying, not selling.

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