The weekly wrap: RBS turns bullish on banks

It was a remarkable week for the banks last week, meaning the week ending July 31. The ASX 200 jumped 3.1 per cent that week, which in itself is a very big weekly gain, but the big four banks jumped an astonishing 7.2 per cent. Weeks like that are very rare indeed, and it is likely it will be a long time before it happens again.

Well, one week is a long time in this market. This week (ending Thursday, 6 August) the ASX 200 gained 3.2 per cent and the Big Four gained 7.8 per cent. That's a 15 per cent increase in two weeks. It makes a mockery of the historical average annual accumulated return on the ASX 200 of about 10 per cent per year.

This week, like last week, the general market was driven by increasingly better (or increasingly less worse) global economic data. The index was also influenced by stronger commodities prices which helped drive the Australian resources sector higher.

But while improving economic conditions are clearly a positive for the banks (reduced risk of loan impairment and foreclosure growth on the one hand, increased demand for credit on the other), the outperformance in the banking sector both this week and last lends itself most definitively to the influence of recommendation turnarounds from leading stockbrokers.

This weekly wrap has noted for many months that the most bearish bank analyst team in the FNArena universe of leading Australia stockbrokers is RBS Australia, which has long declared the market to be underestimating the potential peak of bad loans ahead as a result of the recession, and failing to price in the likelihood of further capital raisings and dividend cuts.

On another occasion this wrap argued that, as other analyst teams were beginning to change their bearish views, if the day ever came that the uber-bear RBS did a back-flip then we would know it was time to sell.

That day has come.

This column does not seek to mock RBS. It is simply a contrarian tenet that when the last man turns bullish the rally is, by definition, over.

The RBS analysts have been stoic in their forecasts and have seen several capital raisings and dividend cuts in the process, as well as steady growth in impairments. They continue to warn that bad debt growth is yet to peak, but now admit bad debts are not "spiralling out of control" and concede capital raisings are likely over for now.

"Recent commentary shows," noted RBS on Tuesday, "that Australia is unlikely to experience the depth of recession first thought and that, while unemployment is rising, it is unlikely to get to double-digit levels. Focus is now clearly on recovery, meaning that share prices are unlikely to re-visit the lows experienced back in March earlier this year, in our view."

And with that RBS "unzipped the bear suit", to use the analysts' own words, and upgraded the banking sector from underweight to neutral. Neutral is not overweight, so arguably RBS has not yet actually turned "bullish". Perhaps the market is saved. But the analysts did upgrade both ANZ and National Australia Bank directly from sell to buy. ANZ has run 56 per cent since the March low and NAB 60 per cent.

RBS acknowledges ANZ and NAB as the "recovery stories". The change in the analysts' sector assumptions drive a sector-wide 15 per cent forecast earnings upgrade for FY10-11 (from the analyst's clearly market-low previous assumptions). Such a change nevertheless does not result in upgrades for the larger Westpac (WBC) and Commonwealth (CBA) Banks, given it is the larger banks with the greater retail presence which are exposed to lingering risk, the analysts suggest. Westpac remains on a Hold rating and CBA a Sell.

However RBS did make substantial target price upgrades to all the banks this week, in line with their earnings forecast upgrades.