It was a strong week (ending Thursday) for the ASX 200 index, driven by supposedly healthy local economic data and a technical breach of resistance both locally and in the United States. For the best part of the week, indices were supported by strength in the resource sector as a weakening US dollar fuelled ever higher commodity prices. In the meantime banks, which have enjoyed reasonable strength until recently, were somewhat left behind and furthermore subject to long awaited shorting capacity.
But it all came crashing down on Thursday, when a bounce in the US dollar and subsequent commodity prices' tumble brought a dose of reality to an over-enthusiastic market. As a result, a 4.8 per cent hike in the ASX 200 for the week was actually surpassed by a 6.1 per cent improvement on average in the big four banks.
Last week more than one broker ran reports suggesting the more defensive "quality" stocks, which in this case include the big two banks, Commonwealth and Westpac, had become overbought and it was time for riskier stocks, which include the smaller ANZ and National, to play catch-up and narrow the gap. On the other hand, FNArena noted that NAB remained the only bank still trading above its average broker price target.
Well, the dispersion argument worked to some extent, given this week ANZ rallied 9.5 per cent to Westpac's 3.8 per cent. But NAB was indeed held back with only a 2.7 per cent rally and CBA just sailed merrily on, up another 8.4 per cent. Westpac is now the only bank still trading below its average target, by 6.8 per cent, while CBA has rallied back to be 3.1 per cent above its target, NAB is still vulnerable at 5.5 per cent above, and ANZ now want to stretch the bounds at 6.4 per cent.
There was no new news from the big four this week and subsequently nothing new from bank analysts. ANZ and Westpac remained tied as top pick ahead of NAB and CBA, and the ratio of buy ratings to sell ratings remains as 8/9.
All eyes have been on the US bond market this week as growing concerns over extensive fiscal debt and rampant money printing have led Wall Street to fear inflation. Inflation expectations have certainly been manifested in higher commodity prices but Australian long bonds have also been drifting higher in yield, already forcing the big banks to increase rates on their fixed-rate loans. While banks like a positive yield curve, given they can borrow cheap and lend dear, a steepening long end is not good for bank share prices.
RBS notes that when the long bond yield rises, the sectors most impacted are utilities, property and banks (in descending order). Investors traditionally buy these three sectors for their yield rather than growth upside, so if the yield on the AAA-rated Australian 10-year bond is creeping up to offer a better and safer investment, then who needs banks?
While that might seem bearish (and none are more grizzly than the RBS bank analysts at present), a more positive report was issued by Goldman Sachs JB Were this week assessing the "look-through-the-cycle" value of stocks. This implies setting a portfolio to take advantage of those stocks which have not only just survived the GFC to date, but which have acquired or restructured or mended balance sheets and stand ready to come racing out of the GFC with solid earnings growth.
On that basis, the Weres' analysts attempted to look past the lagging bad debt peak to when the banks are safely on the down-slope of that curve once more.
Weres expects bad debts to peak in the first half of the 2010 financial year. Thereafter, the analysts expect bank return on equity levels to jump from the seven per cent to 15 per cent range achieved in the first half of the 2009 financial year to somewhere in the range from 17 per cent to 20 per cent.
Weres assumes that fallout from the original sub-prime crisis and credit crunch in general will be stricter industry structure. While regulation will no doubt lead to stricter tier one capital ratios for the banks (Weres suggests nine per cent in Australia compared to the current average of 8.4 per cent), the recent consolidation of the sector, as well as the end of unfettered securitisation and unregulated loan broking will mean a continuation of stronger banking margins for the big four as the economic cycles produces respectable levels of growth.
But despite the analysts' 17per cent to 20 per cent average forecast, it's very much a case of winners and losers.
Weres was one of the more vocal proponents of the dispersion argument last week (CBA, WBC overvalued and ANZ, NAB undervalued). The analysts note CBA is currently trading at 1.9 times book value, and Westpac 1.6 times, while NAB boasts only 1.3 times and ANZ 1.2 times. Thus the bank analysts at Weres calculate ANZ is showing 28 per cent upside to its current share price on "through-cycle" return on equity, and NAB 20 per cent, while the biggies are looking rather sad at only two per cent for Westpac and negative four per cent for CBA.
This ranking, while cogently argued, is consistent with the broader view of the major banks' stocks in the FNArena analysis of broker ratings, which have ANZ as first pick and CBA as fourth.
Among the diversified financials this week, analysts have taken on board the Macquarie Group capital raising bonanza (and stag-alicious opportunity for shareholders) to dilute earnings per share forecasts but raise share price targets by an average 2.1 per cent. The average target for Macquarie is now $33.77, but shareholder enthusiasm has now sent Macquarie into premium-over-target territory for the first time in a while, at 6.7 per cent.
In a postscript to last week's assessment of Suncorp-Metway's disappointing bad debt and earnings numbers, Macquarie the broker has since downgraded the stock from outperform to neutral. The analysts suggest that while Suncorp's appeal lies in the takeover potential of its ailing banking division, it is so ailing that no one's going to be in a hurry.
Suncorp now moves to a 3/6/1 buy/hold/sell ratio in the FNArena database, equivalent to both ANZ and Westpac.