The Madometer is putting out a contrarian bank sell signal:
…Remember that most of the arguments against holding the banks weren’t necessarily attached to any intrinsic worries over earnings. In fact the key case against them was that that the yield play had simply gone too far — that the banks were just too expensive.
…in an ultra-low rate world, investors looking for income are prepared to pay a premium for blue-chip stocks that pay a stable dividend that have a demonstrated history of growing that dividend with strong underlying earnings. That’s Aussie banks. Indeed, according to IRESS, the banks have only ever cut their dividends once. That was during the GFC. So unless you’re expecting another GFC, there’s nothing much to be concerned about.
This is the crux of the matter and the only reason that banks have been trading well above historic multiples. So, the two questions you need answered about banks is will bond yields continue to rise and is there an event coming that will hit earnings?
On the first, for me the answer is a very clear no. The global shift towards bond selling is related to better growth prospects and rising oil prices. The first is only marginal and the second is likely going to reverse.
Thus I expect the global bond sell off stop though once US growth rebounds from the Q1 slump upwards pressure on yields will still come from that quarter.
Locally, we’re into a period of waiting for iron ore prices to resume falling and the RBA will pause until then so the selling at the long end makes sense. The short end is already oversold given more rate cuts are coming.
In short, in terms of yield, banks will rebound as bonds come back into vogue.
The second question of earnings sustainability is more tricky. In the medium term I do think that Australia is headed into its own GFC event in the form of the mining bust eating up monetary and fiscal policy ammunition followed by whatever the next global shock turns out to be.
But even before then the shift in the regulatory regime is an increasingly serious banking headwind. Two of the major banks are already diluting shareholders as they raise capital to meet post-Murray Inquiry criteria. The others will follow. And then there is the impact of macroprudential measures such as investor loan limits, foreign property buying limits and SMSF constraints. All of these will slow housing and bank earnings in the context of struggling economy.
The upshot of all of that is that the near perfect context for bank earnings that’s been in place for three years is turning much less favourable, if a very long way yet from disastrous.
That means that the banks can no longer be priced for perfection, and face the risk of being de-rated as the headwinds rise. A higher dividend will be tempting but it now comes at the real risk of capital losses.