Australian Banks – Cheap or Expensive?
We’ve been on the record now for over a year, calling the Australian banks as very expensive. Recent weeks have somewhat vindicated that call but the rally in recent days has also seen losses pared back. one of the main criticisms against our call has been the notion that banks are too big to fail. As one person told us this week “the government will always bail out the banks”.
The above is factually true but not the point. When we talk about banking shares, we are discussing the value of their common equity. Equity is the lowest form of corporate ownership, equity holders are the last to get paid when a company becomes insolvent – during a period of financial concern, the government and regulators seek first to bail out deposit holders, then debt holders. When the government bails out banks, this is often accompanied by an equity capital raising. Again equity holders are the biggest losers, they are faced with the option of having to fork out more money into the capital raising or face major dilution.
It’s easier to change our call, lock in recent profits and walk away from our negative call on banks. But its not the right thing to do and we won’t do it. We aren’t tempted by short term profits. We want to pick long term, meaningful market trends that can create substantial trading opportunities for our clients. Earnings have peaked for the Australian banks.
We don’t expect to see bad debt issues in the near term, but we do think the Australian banks will struggle to maintain their above-global industry margins. Volume growth will be impacted by a slowing economy – some are calling for a recession in Australia over the next year or so. Either way, the trend is still negative.
Banks make money by pricing risk through their balance sheet. At some point in the cycle, that exercise turns sour. We have hundreds of years of example to go through. The Australian banks have been riding this super-cycle for more than two decades and history suggests that at some point, the Australian banks will see their record profits peak and start to reverse. The risk to reward ratio tends to support this.
We’re sticking to our guns unless we see a fundamental change, which we haven’t this week.
I’ll talk more about the banks this coming Monday night. As I mentioned above, the Australian banks look like they are in the foothills of a major reversal. What does this mean for your portfolio? Tune in and see my full thoughts plus an opportunity to ask question. Make sure you get in early and register for the upcoming webinar by clicking here.
These are our initial impressions only, for further details please do not hesitate to get in touch with the Invast team.
Chief Market Analyst
Invast Financial Services