How banks and resources could move in sync

Deutsche Bank reckons a rise in both the resources and bank sectors isn’t out of the question.

As commodity prices bounced this year, materials stocks have risen, while banks have fallen.

Switching between the banks and resources companies has long been a popular strategy among traders and active fund managers, due to the supposed defensive characteristics of the banks and growth features of the resources companies. But Deutsche Bank says a rise in both sectors isn’t out of the question.

Since commodity prices bounced off extremely low levels this year amid mine closures and surprising economic resilience in China, the S&P/ASX 200 Materials Index has risen 29 per cent.

At the same time, the S&P/ASX 200 Banks index has fallen 8 per cent on slowing loan growth and growing ­pressure on margins, dividends and capital. Indeed the two biggest sectors of the domestic sharemarket have broadly diverged since the peak of the mining boom and the resumption of interest rate cuts in 2011.

Weaker commodity prices hit the resources sector, while lower interest rates boosted house prices and home loan growth, and banks were turbocharged by the yield trade until they started raising capital last year.

However, Deutsche Bank’s analysis finds that banks and resources have jointly outperformed the benchmark S&P/ASX 200 with some regularity in the past 25 years, particularly before 2012.

“The last four years have been unusual, with resources and banks rarely outperforming together,” Deutsche Bank equity strategist Tim Baker says.

“Looking at the period 1992-2011, resources and banks jointly outperform almost one-quarter of the time. And if one of the sectors is outperforming, the other joins in 40 per cent of the time.”

In fact the lack of joint outperformance of banks and resources in the past few years is one reason why Baker now feels that some “normalisation” is due and that joint outperformance is possible.

Also, banks and resources now account for about 5 per cent less of total market value than the long-run average — lower than any time since the dotcom bubble of the late 1990s — and this makes it easier for investors to be positioned in both.

Baker also says banks and resources now look cheaper than the rest of the market, which will make them attractive to some investors. On a price-to-book basis they’re below the long-run average, whereas the rest of the market is 10 per cent above, and the valuation gap is similar on a forward PE basis, assuming something close to current commodity pricing.

Deutsche Bank’s model portfolio is sticking with an “overweight” view on resources and a “neutral” stance on banks for now, but Baker says he’s open to overweighting both sectors.

“On the banks, we recognise the value, with the relative PE around record lows, but softening credit growth keeps us on the sidelines,” he says. “The three-month rate of growth has hit a three-year low, and we think that’s underappreciated by the market.”

He’s more confident on resources because while share prices have run ahead of forecast earnings, they’re still some way short of earnings on a spot basis.

As the old timers like to say, you sell resources on low PEs and buy on high PEs because commodity prices are hard to predict and resources analysts tend to end up tracking spot prices.

Baker also notes that analyst sentiment is still on the bearish side for the resources sector, yet its performance is well below the long-run trend, and China’s economy has improved, with Deutsche’s macro indicator hitting a two-year high in September. He also points out that the resources sector tends to track emerging market equities, which are currently getting boosted by inflows.