Contrary banks

It is the foundation of capitalism that the market is always right. The share market is a pure example of this; each price is supply and demand in action. Each share price represents the price at which a buyer is willing to buy, and a seller is willing to sell. If the market is always right, then the bank analysts are wrong.

Source: Bloomberg, Market Vectors

Brokers, with a few exceptions, have rated banks ‘hold’ or ‘underweight’ but the share prices keep going up. Current and forecast price-earnings ratios, price/earnings growth ratios, price-to-book ratios and all the other conventional measures of the four big banks are, by historical standards, expensive. Yet the banks’ values keep increasing.

Michael Lewis told the story of the off-field strategies of the 2002 Oakland A’s baseball team, who with a quarter of the budget of the much richer New York Yankees won more games. The story told in the book and subsequent film, ‘Moneyball,’ is that baseball scouts were all using the same conventional statistics such as batting averages and bases stolen as well as qualitative measures such as whether a player looked like a baseballer. These qualitative measures were subjective and over time all the scouts had converged to the same view. As a result, success rates from draft picks among teams were low. This suited teams with bigger budgets who could pay for the successes when they became available. Billy Beane, the General Manager of the A’s, used unconventional measures to find players who didn’t fit the traditional mould, but would have a higher chance of succeeding. By not listening to the experts but understanding what really drove performance, Beane surprised everyone.

There are a few key reasons that the prices in the banking sector are going up contrary to the analysts’ expectations based on the conventional financial metrics. These are:

1. The consistent flow of capital into the Australian share market;
2. The behaviour and future needs of investors in the market; and
3. The ‘risk’ of bank share investing has been nullified by government intervention.

The superannuation guarantee ensures that each year 9.25% (9.5% from July) of each worker’s salary is invested. A large percentage of this money is invested in domestic equities. Australia has the highest pension allocation to domestic equities in the OECD . If this money is invested by fund managers, it is likely that they will invest in banks as they often have a benchmark that includes the banks as a large percentage of their investments (the big four banks make up over 30% of the S&P/ASX 200 Accumulation Index).

Additionally, many retirees, including those with SMSFs, are in pension phase. A fund in pension phase is likely to be attracted to income generating assets such as banks, which pay a fully franked dividend. The sheer weight of money going to banks is likely to mean that share price momentum will be sustained over the medium to long term. As the population ages, the need for income generating assets will increase.

Just as the baseball scouts did not correctly value Jeremy Brown because of his perceived need to lose weight, there are factors in investment markets that statistics or conventional wisdom cannot value. Analysts do not consider the behaviour of investors. We know something about how investors shop. In the absence of price, consumers are likely to be attracted to brands that they know and understand. Investors’ psychology will drive them to an investment in banks rather than an investment in a company that they have never heard of or one whose earnings they do not understand. In all, 14 of Oakland’s 2002 draft picks went onto play major league baseball, including Jeremy Brown. This number was remarkably higher than in previous years and represented a higher draft success rate than other teams experienced.

Banks are considered relatively ‘safe’ investments and since the GFC they appear to have become safer. During the GFC banks in the US, UK and Europe were allowed to fail. The unprecedented impact was that governments now cannot seemingly allow a bank failure to happen. Investors are willing to pay a premium for feeling safe, and at the moment they are not being charged a premium for this safety. Bank shares are still providing relatively high income, compared to cash and fixed income rates. There is plenty of scope for yields to decrease before investors move to what they perceive to be riskier stocks.

The banking sector in Australia behaves differently from other sectors within the economy, contrary to ratios, sentiment and history. Only MVB gives you access to all of the banks in a single trade.

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