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Banks a buy in 2018

David Bassanese
Wednesday, December 06, 2017

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Banks stocks seem a great buy in 2018. 

Don’t laugh – I don’t mean local bank stocks, but rather their global peers due to the divergent fundamental forces each are likely to face over the coming year.  The good news for local investors, at least, is that it’s never been easier to buy exposure to global banks on the ASX through international sector exchange traded funds (ETFs).     

Locally, the story is not so great.  Given the challenges that have faced the local share market in recent times it’s a shame from an investment perspective that the financial sector – clearly the most dominant on the market – must now endure another wrenching period of regulatory risk as a hastily organised Royal Commission starts its work.

We already know two things about Royal Commissions: they are colossally expensive for taxpayers, and very slow in reaching their conclusions.  And even then, Governments are under no obligation to agree to any of their recommendations.

In the meantime, we’re likely to get a plethora of speculative headlines over what new burdens may or may not be imposed on our major banks.  In a way, it will be a bit like the nervous wait the market endured as the Australian Prudential Regulation Authority deliberated over what new capital requirements to impose on the banks so as to make them “unquestionably strong” by global standards.   

As it turned out, APRA’s new capital requirements were not as bad as feared, meaning banks did not need to raise a whole lot more shareholder dilutive equity or slash dividends.  But overall, the financial sector is now trading at lower prices then when APRA finally declared its hand back in July this year.  Negative headlines over one bank transgression after another has not helped, nor has signs of cooling in lending to the property sector – thanks to APRA’s clamp down on investor lending and interest-only loans.

The shame is to the extent that certain problems have been identified in the banking sector, specific new regulatory changes could and should have dealt with them much more quickly and at less taxpayer cost.  The problem is that Labor’s call for a Royal Commission has proven so politically irresistible than no matter what the Turnbull Government did (even having a say over executive salaries and bonuses!) was going to be viewed as too lenient in comparison. 

In short, the growth opportunities in the local banking sector – especially also given the slowing in the important Sydney property sector – appear limited. That said, given the Bank’s still strong pricing power – or ability to price mortgages at a levels comfortably above borrowing costs – they should still be able to churn out healthy steady profits and dividends.  The Big-4 banks are really modern day utilities – good for income but not much growth.

The global banking sector, however, appears to have a more positive outlook – at least over the coming year or so. For starters, the profitability of global banks in general tends to improve as longer-term interest rates rise, and especially if yield curves steepen. There’s a strong positive correlation, for example, in the relative performance of global financials and US 10-year bond yields.  As a result, the winding bank of massive bond buying programs by the US Federal Reserve – and slowly but surely the European Central Bank – should help global financials in this regard.

 Love or hate him, US President Trump is also poised to unleash a massive tax cut package which will favour relatively highly taxed US sectors such as financials, and he’s still vowing to cut back on financial regulations.

Global banks went on a tear in late 2016 when bond yields last spiked higher and Trump came to power.  They’ve since kept pace with the global equity rally so far this year but are possibly now poised to enjoy a period of outperformance once again.       


Indeed, while there’s been a lot of focus on Australia’s low exposure to the booming technology sector – and mixed performance of commodity prices – another major factor behind the underperformance of the local market against global peers this year has been the underperformance of local financials versus global banks.   This drag on local relative performance does not seem like ending anytime soon.

Published: Wednesday, December 06, 2017

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