Bet against bank stocks at your own peril

Yet again a scare campaign against banks has failed to materialise. Here’s why!

Banks’ share performance

Bank stocks are the backbone of just about every share portfolio in Australia. Yet, on an entirely predictable basis, this crucial investment category regularly endures a scare campaign.

And the worst aspect of these scare campaigns is that smaller shareholders lose out; they sell bank stocks into what invariably transpires as a dip, not a downturn, and again the big end of town wins and the private investor loses.

In the middle of last year a ­barrage of research reports suggested the banks were about to weaken in the face of a trio of ­alleged threats:

• Huge capital raising was coming down the track.

• A bad debt blowout was looming, especially in Queensland and Western Australia.

• The hunt for yield was coming to an end.

In fact, some bank stocks were even on the “most shorted stocks” lists.

What happened? It turns out the expert calculations on how much more capital banks would have to raise due to new global regulations were entirely academic; in most cases they will never need to do it.

As each month passes, the banks naturally strengthen their balance sheets.

Bad debts have not blown out — they are not even at long-term averages and the hunt for yield may be over but with the big four banks offering an average dividend yield of 5.7 per cent that sort of income still outstrips cash dramatically.

While the rest of the market were losing its head about the coming collapse in bank stock ­prices, the smartest investors were actually going in and picking up bank stocks at discounted prices. Geoff Wilson’s WAM Leaders fund, which focuses specifically on mispriced assets, spent the pre-Christmas period accumulating bank stocks and the profits from that exercise underpinned WAM’s recent results.

Matthew Haupt, portfolio manager at WAM Leaders says: “With banks now bad debts are ­benign, competition for deposits is easing … we don’t see any of this gloom and doom.”

The bank’s won’t admit it — and no broker report will spell it out — but the greatest strength of the big four banks is that they are a cartel.

Quite simply, they make the rules for the isolated market which they utterly dominate.

They are price givers, not price takers, and that makes them very hard to beat as long-term investments.

What’s next?

So where to now for bank stocks? This week’s results from Andrew Thorburn’s NAB offered little guidance for the wider sector.

But the Trump era has changed everything for the sharemarket, especially the financial sector which can look forward to better margins as rates increase. Yet there is a string of new very negative notes from leading brokers: Citi placed a sell on both CBA and Westpac on January 20 while Morgan Stanley followed up on Tuesday with an underweight ­recommendation on NAB.

Brokers openly fret on the revenue weakness in Queensland and Western Australia, the rise in costs facing all banks (clearly on display in this week’s muted results from NAB), the ever present threat of new technology players who can cherry pick the sector and most notably the prospect of bankruptcies and bad debts in the oversupplied apartment sector.

But here’s the thing: the big four cartel is at its most efficient in its control of the Australian residential property market and it will pull the strings at just the right time where profit is maximised and damage is minimised.

The banks had been tinkering around the edges and putting brakes on the speculative end of the property market with tighter rules for investors and interest-only owner occupier loans.

But then the government’s ­dramatic plan to squeeze both the tax benefits in retirement and the tax advantages of contributing to superannuation in the accumulation stage saw a whole wave of new money enter the investment property market.

This shift came just in time to offset a softening of money coming from China to the apartment market (see Roger Montgomery’s column below).

Now the banks have moved ­seriously to protect profits in the residential market without choking off the best cash flows.

CBA, the nation’s biggest lender ­announced midweek that it would put a temporary halt on ­refinancing of home loans from outside its existing customer base.

From a consumer point of view, this is typical from the banks: just when a large number of investors are finally convinced rates will ­finally start moving up, the ­nation’s biggest lender cuts off the chance to refinance.

But from an investor’s point of view, it’s a neat piece of engineering which no doubt other banks will follow; in fact, pretty soon we can expect the entire banking ­sector led by the big four to put a clampdown on refinancing, and all those investors who might have escaped to the record low rates of 2016 get trapped hard in the higher rates of 2017.

It’s ugly and it’s smart and that is how our big banks work; they dominate and they win in almost every conceivable climate.