Faith in flying banking sector over miners poses a ‘material risk’, says Citi

Australian banks have outperformed the miners since late 2023 but Citi believes having too much emphasis on the financials could pose a ‘material risk’ for investors.

Commonwealth Bank’s share price is up 27 per cent in the year to date.

The outperformance of Australian banks compared with miners since late 2023 has been extraordinary.

The banks index is up 43 per cent and the materials index is down 16 per cent in that time.

Many analysts have unsuccessfully called for a pullback in banking stocks and a switch to resources.

But banks continue to perform strongly. The Commonwealth is up 27 per cent in the year to date while BHP is down 2 per cent.

As the banks and materials sectors together represents about 45 per cent of the Australian market, getting the sector share right is crucially important for fund managers.

In this regard a “lopsided barbell” in their portfolios is a “materials risk”, according to Citi.

Moreover, Australian mining stocks now offer a better risk/reward trade-off than banks and investors could be “wrong footed” by switching to miners, Citi analyst Thomas Strong said.

“Over the past 18 months, this has been a one-way ride for investors, with the banks outperforming materials/market,” Mr Strong said in a research report released early Thursday Australian time.

Yet from a fundamentals perspective, banks’ relative outperformance was looking “tired”.

“Earnings expectations are being downgraded for the banks and their valuations look full,” he said. “Materials valuations look better value, with earnings growth.”

The difficulty is often being able to see the catalyst for a switch before it happens.

Analysts thought they had one last September when China started promising major fiscal stimulus.

But after repeated disappointments with the scale of stimulus plans from China, as well as the eruption of US President Donald Trump’s trade war in April, the ASX 200 Materials index hit a two-and-a-half year low.

The ASX 200 Banks index also dipped in April, but as Australia’s major banks are considered “defensive assets” during the trade war, the banks index hit a record high this week.

Defensive they may be, but only as long as their bad and doubtful debts are stable;

however, the banks are highly leveraged to the economy.

The Reserve Bank has started cutting interest rates although it is somewhat constrained by the fact that underlying inflation is at the top end of its target band and unit labour costs are uncomfortably high.

The domestic economy appears fragile after quarterly growth slowed to 0.2 per cent in the March quarter.

Outside of the Covid-19 crisis it was the slowest quarterly growth rate since the early 1990s recession.

A downturn in China may be the biggest risk for Australia, but if the domestic economy were to have a recession for any reason it’s debatable whether mining stocks would fall as hard as banks.

Mr Strong doesn’t predict a catalyst to get more bullish on miners at this point.

However, as the sharp rotation last September showed, investors may not have enough time to switch between banks and materials when catalysts do present themselves.

“Consequently the need to be mindful of portfolio positioning in advance,” he said.

Citi has a buy rating on BHP while NAB and Commonwealth are its highest conviction sells among banks.

Originally published as Faith in flying banking sector over miners poses a ‘material risk’, says Citi