‘Too much optimism’ on banks, Morgan Stanley warns

A leading analyst says Australian investors are too optimistic about the outlook for major banks after a strong rebound in the stocks over recent months.

A leading analyst says the share market is too optimistic on banks after a strong rebound

Morgan Stanley thinks investors are too optimistic about the outlook for Australian banks.

After a strong rebound in recent months bank share prices now imply that the domestic economy will achieve a “soft-landing” rather than a more “bumpy landing” that it expects.

“Our analysis points to further upside in a soft landing scenario, but meaningful downside if there’s a bumpy landing,” said Morgan Stanley Australia banking sector analyst, Richard Wiles.

It came as NAB economists scrapped their recent expectation of a final interest rate hike from the Reserve Bank in February. NAB now expects the RBA to start cutting rates in November, eventually lowering the cash rate from the current level of 4.35 per cent to 3.1 per cent by the end of 2025.

All of the big four banks now think the next move by the RBA will be to cut interest rates.

The S&P/ASX 200 banks index fell about 16 per cent from February to June as costs increased and investors feared that intense competition for mortgages would hit net interest margins while a so-called fixed-rate “mortgage cliff” would increase bad debts.

But the housing market was supported by high levels of immigration, mortgage discounting moderated, banks restarted share buybacks and rapid disinflation gave hope of interest rate cuts and a soft economic landing. The banks index rebounded about 18 per cent, surging about 13 per cent rise in the past two months as expectations of interest rate cuts caused a jump in valuations.

This month, NAB and Westpac shares hit their highest levels in almost a year, and ANZ shares tested multi-year highs.

CBA hit a record high of $114 amid a strong rise in the overall share market.

Westpac fell 0.7 per cent on Wednesday as Morgan Stanley cut its rating to Underweight.

CBA also fell about 0.6 per cent. Mr Wiles said CBA was the most vulnerable bank to a bumpy-landing scenario that might crimp share buybacks and fuel some worries about dividends.

ANZ was expected to be the most resilient of the banks and was rated at Overweight.

NAB was raised to Equalweight due to its favourable business mix, sound retail and business franchise performance, cost management, excess debt provisioning levels and strong capital.

Mr Wiles said the overall price-to-earnings valuation of the big four, led by CBA, had risen even more in the recent episode than it did during the RBA’s rate cutting cycles of 1996-97 and 2011-13.

Commonwealth Bank shares hit a record high of $114 this week. Picture: Britta Campion / The Australian

The recent share price rise “largely reflects the prospect of multiple rate cuts in 2024 and a more optimistic outlook for the Australian economy and banks’ earnings over the next two years.”

Based on his estimates, the average price-to-earnings multiple of the major banks is now about 15.3 times the consensus forecast of their total earnings per share.

The price-to-earnings valuation was above both the post-Covid three-year average of about 14.4 times and the pre-Covid 10-year average of about 12.2 times, “suggesting to us that share prices already reflect a more positive outlook,” Mr Wiles said.

Looking ahead, the share price performance of the banks will be influenced by the outlook for domestic inflation and cash rates, competition and margins, credit quality trends and the potential for provision releases, and the prospects for new buybacks and ongoing dividend growth.

According to Morgan Stanley, this optimistic outlook will need to be validated by an even stronger housing and mortgage market, less mortgage ‘front book’ discounting, meaningful mortgage ‘back-book’ repricing, further share buybacks and ongoing growth in dividends.

“In our view, too much optimism is priced in, so we have a negative stance on the major banks,” Mr Wiles said.

Positively, a hard landing or recession isn’t expected. Rate hikes look to have finished with a still strong jobs market, a recovering housing market, and an improved Federal government’s fiscal position. Consumers still have a savings buffer in aggregate, bank balance sheets are healthy, credit markets are sound, public investment is elevated and the terms of trade are favourable.

Rather, Mr Wiles expects the economy to experience something between a soft and bumpy landing.

In a soft landing, consensus earnings per share estimates would be upgraded by an average of about 9 per cent and trading multiples would be maintained, with NAB likely to perform the best.

But in a bumpy landing, Mr Wiles sees double-digit downgrades to consensus estimates for fiscal 2025 and a trading multiple de-rating. ANZ’s share price may be the least vulnerable.