All investors need to understand why Australian bank shares are among the most expensive in the world at a time when the margins of a key business – home loans – are declining.
And paradoxically, Commonwealth Bank shares have outperformed other banks, yet it has the largest share of the tough home loan market. On Tuesday it closed at a new all-time record high of $155.61 per share.
Adding to the share market contradictions, Australian governments have committed to spend $650bn on renewable and gas power between now and 2050. After 2050, we basically have to do it all again at a much higher price because of the limited life of renewables.
This huge strategic investment commitment triggers much higher power prices to enable capital providers to gain a return on their investment. And such an enormous expenditure will underwrite high or higher Australian interest rates, which in turn will maintain tough housing conditions for banks well into the future.
Many businesses will thrive on the outlays, but others will simply will not be able to survive under the weight of higher power costs and long-term high interest rates.
In the last year, the vast majority of Australian new jobs have come from areas relating to government. Most do not add to productivity and via the industrial relations legislation the government has set rules that are aimed at reducing productivity.
And yet we have the banking industry, which is at the kernel of these government challenges, en joying a strong share market. There are two separate reasons.
Large superannuation funds are required to invest a substantial portion of their money in Australian equity. In theory, they could greatly increase their investment in the non-listed equity sector, but the flexibility and liquidity provided by listed securities enables superannuation fund members to switch their funds.
And because the Australian listed share market is not expanding via IPO’s and is dominated by bank shares, the banks receive a substantial portion of this avalanche of money coming into super funds.
In addition, when global share fund managers want to short China, they often short sell Australian shares, including banks. This happened some months ago, but in recent times there has been short covering which has created extra buying of Australian bank shares – particularly the CBA.
The combination of these three forces has boosted all banks, but CBA shares have hit a higher price earnings multiple than JP Morgan in the US. There is a danger these Australian bank high price earnings ratios may cause long term overseas holders of Australian bank stocks to sell out because we are too expensive. And once out of the market, they may never return.
Meanwhile, banks are looking hard at their operations as they seek to overcome the industry problems and justify their share prices.
Very foolishly, some years ago, banks lost control of their home lending customer base by outsourcing the recruitment of loans to brokers. The banks no longer have close relationships with the bulk of their home lending clients. In the short term, this enabled costs to fall because branches were shut and some of the bureaucracies involved in bank home loans approvals were dismantled.
Now banks are trying to claw back market share, but it is not easy because people seeking home loans often don’t think about going to banks first – they go straight to the broker.
Currently, the restrictions on bank lending on houses make it almost impossible for young people to gain approval for the level of loan required to buy a dwelling unless the grandparents or parents supply funds or guarantees. In turn, this depresses home loan volumes.
There are now moves to allow more money to be loaned by banks to help first home buyers, which will help, but what is really needed is lower interest rates.
The outcomes of government actions have so far prevented lower interest rates. The Albanese government is hoping for an interest rate cut in February or May, and it may be lucky.
But retailers are now telling me demand is strong, which is not good for those looking for interest rate reductions.
And a couple of small enterprises I have been talking to, like so many others, have been battling higher costs this year but have finally decided to lift prices on December 1. They're bracing for a reaction. But they had no choice. One said many young people had given had ‘given up’ on saving for a home or distant goals because they were too depressed by the climate change outlook and the rhetoric around housing affordability.
This also makes them less interested in working hard, which further damages productivity.
Whoever wins the next election, whether it be the ALP or the Coalition, they are going to be forced into a more rational set of decisions on the allocation of capital.
The advent of the US Trump government means the US twill be demanding we also lift our expenditure on defence and satellites. And if we complain, the US will say cut your power construction costs and/or reduce your public service – just as we are doing.
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