Australia’s major banks have rallied strongly in recent weeks as the overall post-Brexit recovery in global markets lifted prices from multiyear lows.
But it’s time to sell the banks again, according to Ross Barker, managing director of the $6.6 billion Australian Foundation Investment Company (AFIC). Barker told the AFR that he is shifting money out of the banks, and other blue chips, and re-deploying the cash into smaller stocks with better prospects of growth.
“I don’t think we can expect much dividend growth from the banks … and there is a risk of more cuts … so we have been reducing our exposure,” Barker said.
He gave four factors which drive AFIC’s view that the dividend stream will come under continued pressure. These factors include already high payout ratios, sluggish economic growth which could weigh on corporate earnings and thus lending to companies, the housing market and the potential for a downtown to lead to bad debts, and of course regulatory scrutiny and APRA’s continued desire to raise the big banks’ capital ratios.
It’s a list of headwinds David Pain, a London based hedge fund portfolio manager, and James Whelan, investment manager at VFS Group, have sympathy with.
In a new report with the provocative title “The War on Banks”, Pain and Whelan give their own reasons why the banks are under pressure.
The authors say anyone who thinks that hedge fund selling of Australian banks is a “widow-maker” trade need to look at the share price of the big four over the past year. They say the narrative that has emerged “that the ‘foreign horde’ (i.e. hedge funds) are trying to ‘take down’ the Aussie banks” might read well and seem like a classic David and Goliath tale, but they “find the premise ridiculous”.
Rather they highlight the banks have declining net interest margins, face regulatory risk from both APRA’s capital requirements and the calls for a Royal Commission, and have increased competition from a reinvigorated small bank sector.
It all means the golden days are now behind Australia’s big four, Pain and Whelan say. They highlight that the high multiples Australian banks have been trading at for years have been justified.
Australian banks have been trading on inflated multiples for many years. This has been justified and rightly so due to their incredible levels of profitability. To offer a comparison CBA generated a Return on Equity (ROE) of around 17% in 2015. ROE is very simply the return generated for every dollar invested in the business. For example, you invest 1$ in CBA and they generate $1.17. In comparison, Lloyds of the UK generated a measly 1.4% ROE in 2015.
But because of the issues they have identified, similar ones to AFIC’s Barker, Pain and Whelan say hedge funds are selling Australian banks.
Pain and Whelan say they don’t “see a happy ending to this story”.
“Markets don’t care about your biases or your feelings and they are certainly not personal,” they said. “Given enough time those holding out hope for the banks will be forced to deal with reality.
“In the meantime they give everyone else time to make their way to the exit.”
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