Bank stocks rally 15 per cent in a week

Australian bank stocks have enjoyed a fabulous run this week, with the big four rising on average by 14.9 per cent by the close of trade yesterday. The ASX 200 rose 7.6 per cent.

With little local news, the driving force was the lead from the United States. One by one, the major US banks have claimed to be making profits, the mark-to-market rule on toxic assets may be relaxed, the uptick rule may be reinstated and the Federal Reserve is throwing even more money at the US financial sector.

As a result, the US banking index within the S&P 500 has rallied close to 50 per cent. This includes moves up from very low price points in the case of banks such as Citigroup.

Locally, National Australia Bank jumped 16 per cent, ANZ 15 per cent and Commonwealth 18 per cent. The already well supported Westpac managed only a nine per cent rise.

The moves came despite CBA chief executive Ralph Norris claiming at a business lunch on Tuesday that "we're in for tougher times going forward" and that CBA's "previous dividend history should not be regarded as a predictor of the future".

It was a case of: "Tell us something we don't know, Ralph". Not one broker in the FNArena database even took the time to pass comment on Norris' speech. Nor did the market find any reason not to buy CBA shares. CBA did raise another $865m in a retail share placement but we knew that was coming too.

While the March rally has not been a complete surprise, and has certainly been welcomed, the bad news is that the big four banks' share prices are either closing in on, or have exceeded, their average twelve-month targets.

In FNArena's experience, every time this occurs it signals a peak in the rally.

One month ago to the day, the gap from closing share price to average target for Westpac and CBA was five per cent, with NAB showing a full 17 per cent gap and ANZ per cent.

There has been some slight tinkering in analysts' target prices in the meantime, including a four per cent drop in NAB's average this week, but as of today, NAB is four per cent from its target, Westpac 0.9 per cent, ANZ 0.6 per cent and CBA has exceeded its target by 6.5 per cent.

What this means is that either the analysts have to upgrade their targets or that the banks have raced too quickly to a point analysts expected would take twelve months to reach.

An upgrade is unlikely, given a rash of recent bank disclosures and guidance updates and the fact that we are heading into a recession, not out of one. It is quite likely we are looking at a short-term peak.

Analysts are not going to suddenly find more earnings potential for Aussie banks. All they could do to raise targets is to find more multiple potential.

History shows that Aussie banks tend to trade on forward earnings multiples of nine to 11 times in periods of economic weakness. They have now, on average, reached 11 times.

It may be that an ongoing rally on Wall Street and further good news for US banks might force sentiment, and thus multiples, higher, but this would only be to make share prices seem even more overbought, one would assume.

You have been warned but not advised.

On a positive note, Goldman Sachs JB Were yesterday released a report suggesting concern over Australian bank exposures to consumer credit cards is all a bit of a storm in a tea cup.

Legendary US banking analyst Meredith Whitney - legendary because she kept her head while all about were losing theirs and began calling a US banking catastrophe ahead in 2007 - has declared bank exposure to consumer credit to be the next big write-down target in the US as unemployment grows.

One might assume Australian banks would be in the same boat. However, Were points out that despite our earlier predilection to spend like there was no tomorrow, consumer lending in Australia as a proportion of total bank lending has fallen to five per cent from more than 10 per cent in the late 1980s and early 1990s.

It seems we were more inclined to abuse the fantastic plastic when Bondy was leading the charge. (Mind you, GE charge cards at individual stores were not all the rage back then).

The upshot is that were there to be a 40 basis point increase in consumer loan losses (being one standard deviation), the Were analysts calculate Australian banks would suffer only a 1.4 per cent to 1.6 per cent reduction in cash earnings.

Such losses would be concentrated in Westpac and CBA, the favoured stocks, which have acquired the more retail-based St George and BankWest respectively.

Were notes that while consumer loans have shown the highest average loss rate over the last 16 years, business loan loss figures have been far more volatile.

Thus business loan losses remain the biggest risk facing the banks at present, albeit no new large exposures have come to the surface recently.

There were no changes to FNArena database ratings this week. With no one bothering to comment on Ralph Norris' treatise there was not much else to be said.

We did end last week with an update from the new NAB CEO Cameron Clyne, who pledged to reverse the bank's dreadful 25 per cent underperformance (total shareholder return over 12 months).

With unanswered questions over exposure to the UK and to toxic CDOs still a stumbling block for NAB, Merrills can't see how the new CEO can make such bold statements.