Sell The Banks?
This post is from the Voice of Reason: Gordon Barratt.
For those that avidly read the business pages, you will have noticed a building theme of late: beating up Australian banks. Every second article seems to be heralding that the halcyon days of the banking sector are in the past, for this cycle at least.
In some ways its hard to argue against their case. The main SELL points behind this call include:
- much of the profit growth has been a result of the winding back of bad and doubtful debt provisions
- the new credit worthiness laws are expected to force the banks into increasing the capital they have to hold on balance sheets as a added safety net against credit crises, such as the GFC
- the high growth environment is giving way to a climate of anemic growth and structural uncertainty
- while higher interest rates are still forecast to be somewhat off, it is widely believed that we are at the bottom of the cycle hence the call “this as good as it gets for Australian banks in this cycle”
- the Australian bank market is very mature, forcing banks to look beyond Australia for growth. As we’ve seen with NAB’s less than successful forays into foreign markets, that adds an element of risk and lower returns on equity (ROE) than they enjoy from their local operations
- the lower the ROE, the lower the PE premium that the market is prepared to pay
- with rising house prices comes higher bad and doubtful debts as households become over-stretched paying ”inflated” prices
- the banks are trading on the higher side of their traditional PE levels
So that’s pretty much the sell side argument. It’s all valid, to some extent.
However, in my experience the banks do retain a safe haven investment status for far longer than expected. These are the reason why banks will probably retain their value, while the popular press is calling for the sector’s head. The BUY Side:
- bank dividends provide a strong and relatively secure income stream in a very low interest rate environment
- in an environment where virtually every asset class looks pretty well fully priced, with the exception of mid-cap and resource equities, it’s hard to find alternatives
- risk aversion is still high making the safe haven investments )banks) more attractive
- bank earnings have proven to be far more resilient than the forecasters suggest.
In an environment where I find very few alternatives, I’m inclined to stick with the banks for want of a better place to invest the funds. Sitting on cash is a zero sum game, although the one comforting fact is your capital is protected if volatility increases.
I’m happy to ride out the cycle, however I am assuming that profit and dividend growth is likely to be subdued and we may experience periods of negative share price performance from time to time.
Are there alternatives. The only two “blue chip” stocks I can find any real value in are Woodside and Flight Centre.
From a sector view I do like the aging population theme. Health Care has proven to be a very good place to invest although dividends tend to be pretty frugal. Its hard to find any real value in the sector. However I suspect Monash IVF, which I keep banging on about, will provide good long term value. The other area of interest is retirement care, which will benefit from structural reforms that have been put in place to encourage much greater private investment which will take the load off governments in future years. Additionally, the growth in beds needs to cope with the increasing elderly population, which provides above structural growth in its own right.