Big short on Australian banks unlikely to pay off for investors

Locals have fretted about reports of US investors moving to trigger a sell-off in Australian bank stocks.

Local investors have fretted in recent days as reports rolled in of major US investors moving to trigger a sell-off in Australian bank stocks, a move billed as a “big short”.

What do they know that we don’t? It’s a very important question because bank stocks — apart from representing roughly 40 per cent of the entire market capitalisation of the ASX — are the backbone of most private investor portfolios.

Certainly, there were signs some months ago that our major banks were trading on lofty valuations — but today the evidence is not at all clear.

What is clear though is that “shorters” play a very different game than investors — they want stocks to fall and can make money out of relatively small and fleeting movements in stock prices. Moreover, there is a play within the game where shorters let reporters know a shorting move is afoot. It’s a win/win because the media gets a news story and the shorting exercise can only be helped by the widespread transmission of negative news.

In fact, I’d hazard a guess that the hedge funds behind this latest shorting exercise don’t appreciate that, because of the combination of enduring high dividends and franking credits in the domestic investment system, bank stocks are very hard to beat as investments for private investors taking their chances in a low growth world, where official rates are 1.75 per cent.

There’s also a chance overseas fund managers may not appreciate that:

● Our banks are explicitly guaranteed in the form of the government guarantee behind every $250,000 anyone may have in any one bank.

● The banks are implicitly guaranteed from collapse as they are too big to fail — the RBA this week moved to put a value on this of up to $3 billion.

That’s not to say there is not a short opportunity for a New York hedge fund here — rather it is to suggest that what may appeal to a high-speed institutional player may not work anywhere near as well for local retail investors.

Here’s why:

● Our major bank stocks are now being offered with exceptionally high dividend yields. This reflects the emergence of a circular system where the yields roll back up whenever the stock prices dip — just now the PE ratios on major bank stocks are a sitting at a reasonable average of about 12 times.

● Separately, the dividend yield on the four banks remain relatively good, averaging near 6 per cent compared to 4.5 for the wider market.

Curiously, just as news of the ‘‘short attack’’ filters through the local market, Moody’s rating agency has released a substantial amount of research in recent days that heavily backs the notion that our banks are among the most solid in global markets.

Moody’s suggests that asset quality has deteriorated at Australian banks but that is of course coming off remarkably low levels — it also makes the point that the balance sheets of our major banks ‘‘remain well positioned to handle an adverse shock with improved capital positions’’. And yes we all know that bank stocks are facing headwinds: slow earnings, troubles in the mining and dairy sector and tighter capital adequacy provisions. Then again, as any value investor will tell you, it is a brave trader who bets against stocks that offer returns on equity in excess of 14 per cent. Market leader CBA, led by Ian Narev, has a 17 per cent return on equity; that’s double the average among major US bank stocks of 8 per cent.

It’s a mixed report card for sure, indicating perhaps a lukewarm environment for banks, but certainly not a sector heading towards a cliff.

In fact, though it’s undoubtedly of interest that our bank stocks are being shorted by anyone from anywhere, it’s worth considering the degree to which this is actually happening.

The Wall Street Journal reported a few days ago that short positions in Australia’s four large banks were up 50 per cent this year — and sit at the highest level since regulators starting releasing numbers in this area about six years ago.

But if you actually look at the list of shorted stocks you’ll find dozens of stocks sitting well ahead of the banks on the shorter’s accounts. In fact there are 58 stocks listed before you get to the first bank — Bank of Queensland with 4 per cent of its stock held by shorters.

You then must go further down still before you find a big four bank — ANZ, led by Shayne Elliott, finally appears as the 85th most shorted stock in the market with 3.12 per cent of its stock held by shorters.

It’s a niche game shorting Australian bank stocks with very few winners to date. It’s certainly no game for retail investors.