Australian’s love their big banks. Not necessarily paying them fees or watching them ratchet up interest rates, but as investors we just can’t get enough of them. In fact, most Australians would be an investor in our banks either directly or through their superannuation fund.
They have been stunning investment performers run over the last 20 odd years. But a few share market experts are starting to wonder whether our beloved bank shares have peaked. Is it downhill from here, or will they continue to outperform the rest of the market?
To answer that, it’s worth looking at why our love affair with the big four banks is so strong. And there are a couple of pretty good reasons.
Firstly, their financial track record. There are few industries that have benefitted more from Australia’s 24 year run without an economic recession. As household debt levels and wages have climbed and interest rates have come down, our banks have been in the box seat to benefit.
Take the Commonwealth Bank, for example. In 1992, as the country was just coming out of recession, CBA shares were worth about $7.20 and the annual dividend was $0.40. Today, the company’s shares are going for around $75.20 and paid $4.20 in dividends over the last 12 months… although its share price did get close to $100 over the last year.
Those are remarkable numbers for any stock, let alone a boring, blue-chip company. Which is the other big reason we love the banks… they’re predictable and pay great dividends. Their domination of the Australian financial services sector has also meant the big 4 banks are among the most profitable in the world.
So, where to from here?
Over the last six months, the big four have lost about 20 per cent of their value as a string of concerns have reared up at once. Let’s pick them apart what the share gurus are concerned about.
Chinese Growth
As we said, the banks have benefitted hugely from 24 years of uninterrupted growth, so there is concern that their golden run could come to an end if the economy slows any further. And with the growth of our biggest trading partner China looking cloudy, the outlook for us has become a bit hazy too.
Mining has been cooling for a while now and the construction sector, particularly on the east coast, has done well to pick up a lot of the slack. This has reduced the reliance on China slightly, but we really need our services sector to increase its contribution to maintain future solid economic growth.
As a believer in Australia’s innate ability to overachieve, we’re backing the economy to keep ticking along as China works through its issues.
Changing Regulations
The Financial System Inquiry is another development that has thrown some shadow on the banks, as the government has implemented changes to reduce risk in our financial system. The big outcome is the requirement for banks to hold more capital, which has seen a round of recent capital raisings.
There has also been pressure to limit lending to property investors as the market has gone through a boom few years, which naturally reduces the amount of business they can do.
However, now that the capital requirements have mostly been met and the costs of these changes are being spread across their operations, these risk have mostly been dealt with. In fact, greater financial stability is a good thing for shareholders going forward.
Sustainability of Dividends
Economic growth concerns and tightening regulations have prompted questions about whether the banks’ record earnings levels (and dividends) are sustainable. And perhaps we will see some slowdown in earnings, especially if record household debt levels end up in more loan defaults as the economy slows.
However looking at the current dividend yields and earnings ratios of bank shares, it’s hard to see a big fall from here. The dividend yields (dividends as a percentage of share price) of CBA, ANZ, NAB and Westpac are 5.5%, 6.6%, 6.6% and 5.9% respectively. And that’s before you include the tax benefit of franking credits.
But share analysts are concerned the current profit growth of the banks is barely beating inflation and this may put pressure on them to cut dividends.
It’s going to be an interesting 12 months ahead for the banks so make sure you check in with your financial adviser or broker.
INTEREST RATE LOTTO
The Reserve Bank Governor Glen Stevens’ wish that interest rates and the economy get off the front page doesn’t quite seem to be happening. The first Tuesday of every month, when the RBA board meets, continues to attract an extraordinary amount of speculation and attention.
Melbourne Cup Day was no exception with an increasing chance of a rate cut because of some weak economic data and very low inflation figures.
The RBA kept rates on hold and, as usual, gave a very clear and sensible explanation of why. It’s one of the really comforting things about the RBA board… it seems so sensible and always with a realistic handle on what’s happening.
Basically the board’s explanation was… yep, we have the capacity to cut interest rates if we want to, but we’re seeing some encouraging signs in the economy, in China and in the US. We’re pretty happy with the way things stand at the moment but we’ll definitely cut if our predictions go pear-shaped.
We don’t reckon you can’t for much more than that.
While some sections of the media and financial markets can get hysterical with every bit of weak economic data (or “chronic pessimism” as Glenn Stevens as branded it), the RBA takes the big picture view… which is what they’re meant to do.
It’s a lesson for all of us. Don’t get spooked by every bit of new data coming out. Focus on what’s best for your business and family while letting the RBA look after the economy.
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