MORGAN STANLEY: The weakness in Australian banking stocks may be just getting started

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While they may have bounced on Thursday, Australian banking stocks have had a rough time of it recently.

Higher bond yields, disappointing earnings results and the risk of regulatory reform have all contributed to the ASX 200 banks index falling close to 20% from its March 2015 high.

After a decline of such magnitude many are now asking the whether it will continue.

Researchers at Morgan Stanley think they have the answer, and it’s not likely to please the banking bulls.

While they’ve “detected interest in looking to fish the current trough in share prices”, in other words seen signs of renewed buying interest, they expect that the sector will continue to underperform the broader ASX 200 index.

Here’s Morgan Stanley’s take:

“We do have sympathy for this cohort of yield-focused investors revisiting the franked income opportunity within Banks, however, on a relative to market basis we continue to feel that continuing Banks’ underperformance to benchmark is a realistic scenario.The prospect of low to flat EPS growth, higher capital requirements, tighter regulatory regimes and a growth-challenged economy – all dampen the outlook, and this extends to dampening the index given the weight of such expectations”.

To evaluate just how long this weakness may last they’ve turned to history as a guide. On previous occasions that the banks have underperformed the ASX 200 by more than 5% – June 2003, November 2006 and July 2010 – it has lasted for a significant period of time.

What the analysis showed was that on each occasion, the period of underperformance for the Banks was circa 18 months – which is a long time in stock markets. So we are possibly only three months in to a long innings”.

Here’s a chart that shows the three previous period that the banks had underperformed.

Based on the headwinds facing the sector, along with history, Morgan Stanley remain underweight the banks in comparison to the benchmark ASX 200 index.

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