Bank stocks: they’re really too much of a good thing

THE exceptional success of bank stocks has unbalanced many share portfolios to extreme levels.

Bank stocks have bloated financial allocations to retail investors.

EARLIER this week we saw a frisson of fear slip through banking stocks. In a sector that is “priced for perfection”, a minor imperfection raised its head. ANZ’s quarterly numbers did not quite make the mark. Worse still, ANZ chief Mike Smith said things were looking tougher ... and ANZ shares duly got sold off mid week.

The wobble at ANZ highlighted a few important factors:

● ANZ has challenges in Asia where no rival Australian bank has seriously tried to expand operations in recent years.

● Bank stocks — in common with house prices — don’t actually rise forever. Poor performance or figures that disappoint the market can be punished.

● Most importantly, it highlighted how Australian investors have become much too dependent on bank stocks and cold logic suggests this will end in trouble for investors who don’t make the right moves.

The Australian stockmarket used to be called a “barbell” market. It has two areas of immense importance: bank stocks and mining stocks. Just now that barbell is wildly imbalanced as the miners get hit hard with falling commodity prices.

On the other, hand the allocation to bank stocks for most investors has become seriously bloated. Indeed, we only have to look at the wider market to see that bank stocks have mushroomed to become 37 per cent of the MSCI Australia index. This is unhealthy ... the last time a sector blew out in this fashion was resources at the peak of the boom when they hit an MSCI index ­figure of 36 per cent. Separately, think for a moment about the countries where the banks utterly dominated the economy in recent times ... Iceland and Ireland. Now that analogy is unreasonable but useful in pointing out the level of concern building over the dependence on bank stocks.

Banks do not release the individual stockholdings of their shareholders but I’ve been told by a senior source at a major bank that the average retail stock holding in this single bank stock is more than $60,000. Put that figure against the average superannuation account balance in Australia of $82,000 for men and $44,000 for women and you get some idea of the scale of this problem.

Put simply the success of bank stocks set against the mediocre performance of broad industrial stocks and the dramas of mining stocks has left local investors, notably investors in retirement who depend on dividends for income, uncomfortably dependent on the ongoing success of banks.

As most people now understand the banks have been “bid up” not due to exceptional operating numbers — rather it is due to their very attractive dividend yields and the prospects the improving credit environment will bring further lifts in lending levels. Inside the investment community just now there is much angst and tearing of hair over attempts to place realistic valuations on bank stocks.

On many metrics bank prices do not add up — Commonwealth Bank, the largest of the banks and most highly priced, is a classic example. The bank stock price continues to rise despite the bank’s clear leverage to rising unemployment, high house prices, mixed consumer confidence and low corporate gearing.

Then again others will argue that “this time it is different”— investors are not valuing banks as stocks, they are using them as proxies for bonds or other fixed income instruments. When a bank pays 3 per cent in a cash account and the same bank’s stock pays 4.5 per cent before franking on its shares, then investors will vote with their wallets. The trend is deep and it is undeniable ... the problem is, of course, that it is a trend and trends end.

Take for example the price earnings ratio. It’s worth observing that CBA is on a PE of 16.3 and a dividend yield of 4.65 per cent. Rio, a mining company that is as well managed as CBA by any estimation, is on a PE of 12.9 and a dividend yield of 4.56 per cent.

CBA is priced at $90 and Rio is priced at $69. Here’s the thing: less than a decade ago as Rio was cruising at $140, market observers were also telling us “this time it is different”. China was industrialising and Rio’s share price was justified by some on its perfect position to supply China with key resources. On some metrics it may well have been justifiable at that moment in time, but that time is now a distant memory.

Today our banks’ prices are probably justified on some metrics — especially the metric of “desperation to find yield”. But we know this elevation of dividend yield to exalted levels of importance will not last forever. It may only last until the next lift in official interest rates.

For most investors the best decisions they make relate to common sense irrespective of “noise”. At the top of the resources boom Rio was $140 against $69 today and the other key players on the mining end of our “barbell” market were also running hot. Many investors wish now, eight years later, they had avoided buying into mining shares at the top of the market. They also wish they had taken some profits on their resource shares. Investors would have done better by laying off some of the risk building up in mining shares and placing the funds elsewhere, such as alternative funds, selected ASX industrials or offshore shares.

The same imperative is afoot now. This time, like every other time, it’s not different.