Australian Banks: When The End Of The Trend?

Feature Stories | Oct 07 2024

Australian banks have run up to historically high valuations, well above expectation. But the tide is beginning to turn, and brokers warn of several factors conspiring to affect a period of bank underperformance.

-Bank valuations reached historical highs
-Super inflows a prime driver
-Competition intensifying
-Signs of housing boom easing
-Rotation into resources

By Greg Peel

Six brokers monitored daily by FNArena cover the four major banks. Between them, they currently have fifteen Sell or equivalent ratings across the four, with seven Holds, and all but two Buys; one each for ANZ Bank ((ANZ)) and National Australia Bank ((NAB)).

Elsewhere, the two regionals Bendigo & Adelaide Bank ((BEN)) and Bank of Queensland ((BOQ)) attract nil Buy ratings, two Holds and nine Sells.

In contrast, Macquarie Group ((MQG)) and Judo Capital ((JDO)) enjoy more Buy ratings than Sell ratings, as does Suncorp Group ((SUN)), which has no Sell ratings, but is in the process of divesting of its banking division to ANZ Bank to become a pure insurance company.

The Australian bank index has risen 38% over the past twelve months, led by the majors. The largest bank, Commonwealth Bank ((CBA)), has risen 33% despite attracting only Sell ratings from brokers, and having done so for some time. The sector has generated an extraordinary total return of 50% over the last twelve months, Wilsons notes, despite a tepid earnings growth outlook and increasingly extreme valuations.

Major offshore banks have also posted strong gains over the last twelve months, Wilsons points out, which have been supported by the Fed's pivot towards an easing bias in late 2023, and expectations that lower interest rates would support "soft landings" across developed economies.

This dynamic has been quickly priced into bank valuations, both on the ASX and globally. In an absolute sense, the ASX200 bank sector's forward PE multiple has never been higher, led by index heavyweight CBA.

Perplexingly to Wilsons, CBA trades on double the PE multiple of JP Morgan which is arguably the highest quality bank in the world, while having a lower return on equity and offering a similar level of earnings growth.

So why have the banks just kept on rising? Clearly no one's paying any attention to bank analysts. In the face of broker warnings, who just keeps buying?

You

...is the simple answer to that question.

New data which has been analysed by Macquarie shows domestic superannuation funds were the standout major buyers of bank shares in the twelve months to June. The data offer a breakdown between super funds and domestic investment funds (ie non-super investments) as well as households, offshore buyers and other sectors.

Super funds increased their ownership of the sector by 1.6% over the period to 29%. This equates to $6.4bn of investment over twelve months and $2.1bn in the June quarter alone. As the banks have not been issuing new capital, someone has to be on the sell-side. Macquarie notes selling has largely come from investment funds (who might be paying more attention to bank analysts) and offshore investors (who may be looking through a more global lens).

So why have super fund managers ignored said bank analysts and just kept on buying? The data, Macquarie notes, indicate super funds have not been increasing their allocations to the banks and indeed remain largely neutral on a mere 0.4% overweight. The reality is super funds have increased holdings to domestic equities overall by 18% over the year, whereas the market overall has increased holdings by 9%.

This implies it is fund inflows, not fund manager strategy, that is driving increased bank buying. The banks are such a significant lump of the ASX200 market cap that super funds, most of which are passive, have no choice but to increase their bank holdings as more funds flow in.

And there is no end in sight. In July this year, the government-mandated super guarantee increased by 0.5% to 11.5% of income and will increase again to 12% in July next year.