By James Eyers
After the Commonwealth Bank’s latest record, analysts and fund managers are wondering whether the hyper-rally in bank stocks can be sustained.
As the $220 billion Commonwealth Bank surpassed BHP to become Australia’s most valuable company this month, the hyper-rally in bank stocks has become the major talking point in markets.
Given the banks’ stratospheric valuations, many investors are scratching their heads and asking: can the eye-popping gains be sustained, or will the big banks – which have outperformed the ASX 200 – fall back to earth?
CBA broke through $133 a share on Wednesday to a record high, before a retreat in major bank shares over the final two sessions. Shares were trading at $131.13 on Friday, down 1.1 per cent but up 25 per cent over the past 12 months.
The Commonwealth Bank is considered the most expensive bank in the world. It has a price/earnings multiple of about 23 times – 30 per cent above its average over the past five years – and a price-to-book ratio approaching three times, which is out of whack with global lenders.
Australian banks are the priciest they have been in more than a decade, relative to the rest of the sharemarket and bonds.
This is making some bank watchers nervous. Jefferies analyst Matt Wilson says CBA is “trading in rarefied air”, “is priced well beyond perfection and cannot afford to miss” when it reports its full-year results on August 14.
Over the past week, AFR Weekend spoke with the investment community to determine the drivers of CBA’s record-breaking run and to see whether the stock may hold its lofty levels.
Most analysts remain negative. Of the 16 covering CBA, 13 recommend investors sell CBA shares; three analysts are telling investors to hold; and none suggest buying more stock. In other words, broker sentiment around CBA was 81 per cent negative.
All year, research reports from broking houses and investment banks have been stuffed with dire warnings about bloated bank valuations and higher interest rates upping pressure on over-indebted customers, forcing up loan losses. However, heeding such advice to sell, at least to this point, has been a tough call.
Over the past five years, CBA has delivered returns of 90 per cent to investors, including capital appreciation and dividends, outperforming the other major banks. There’s a broad consensus that CBA is a very well-run bank.
“CBA is a standout in the banking space, both in metrics – quantitative – and management – qualitative,” said Matthew Haupt, lead portfolio manager at Wilson Asset Management.
Yet, other reasons are emerging that could explain CBA’s rapid run-up. These relate to technical supply and demand dynamics, including, intriguingly, the shift towards passive investing.
Given CBA represents 8 per cent of the ASX 200 index, for every $1000 that flows into index funds linked to this benchmark, $80 will look to buy CBA shares. Demand for CBA scrip is also boosted by its share buyback and the “neutralisation” of its dividend reinvestment plan.
Meanwhile, on the supply side, many retail investors – who make up half of CBA’s register – are reluctant sellers, who are addicted to its dividend income or want to avoid crystallising huge capital gains if they sell.
Bitcoin, houses and Birkins
“The dynamics of Australian bank share registers are likely the most important driver of Australian bank share prices,” veteran analyst Brian Johnson told clients of MST Marquee, the research platform of MST Financial, this month.
“In any asset class – gold, bitcoin, Sydney house prices, Birkin handbags – if buying demand overwhelms supply, value means little and momentum creates a vicious and painful upward price squeeze,” he said.
Mr Johnson is one of the few analysts recommending to hold on to CBA.
And, as CBA represents a larger proportion of the index – at the expense of shrinking iron ore producers – local institutions have had to buy more just to hold an underweight position. Furthermore, the stronger Aussie dollar makes US dollar-benchmarked international investors more underweight, forcing them to buy too.
However, the exact role index buying has played is hard to nail down.
Analysis published by Macquarie this week showed net buying in CBA from domestic and institutional investors in the June quarter was partly driven by index funds, while retail investors were net sellers.
Net inflows into Australian exchange-traded funds were about $30 billion in 2022 and 2023, compared with net outflows of about $60 billion for active strategies over the same period, Morningstar and Betashares data suggests.
“So the CBA price is being driven by the perfect storm of relentless buy-side pressure combined with limited sell-side activity,” explained Romano Sala Tenna, portfolio manager at Katana Asset Management.
CBA shares have the economy on their side too, as house prices prove resilient and banks’ credit losses are forecast to remain low. The government’s July 1 tax cuts provided further relief.
Economic fundamentals are just as big a driver of CBA as the dynamic playing out on its share register, said Andrew Martin, a principal at Alphinity Investment Management.
“The economy has held up better, which has meant credit quality, volumes, and house prices are OK. Moreover, the ultra-aggressive competition we saw in mortgage pricing 12 to 18 months ago has eased. Banks have had net earnings upgrades, and in a market that has a scarcity of upgrades, that does stand out,” he said.
The more bearish analysts point to the risk that stubborn inflation in Australia will result in interest rates staying higher for longer – a risk the International Monetary Fund warned on this week.
“Would this be enough to derail the consumer and mortgage market and cause a deterioration in asset quality?” asked UBS analyst John Storey.
Bank earnings outlook
Macquarie said the outlook for bank earnings was simply not strong enough to support the share price optimism. Despite delivering 30 per cent to 45 per cent total shareholder returns over the past year, and multiples expanding by about 30 per cent, banks’ earnings have actually declined.
Macquarie analyst Victor German said the odds of the RBA achieving a soft landing had diminished, and there’s a risk the market will reassess abnormally low impairment charges if interest rates stay elevated.
“While multiple expansions often precede the earnings growth phase, this is an improbable outcome, in our view,” he said. “Periods where the earnings subsequently lifted to support rallying share prices were generally characterised by normalising credit losses following an impairment cycle. On the contrary, banks are now experiencing one of the lowest bad debts on record, and impairment charges cannot underpin an earnings recovery over the next few years.”
Alphinity principal Andrew Martin says at some point the market will get more concerned about credit quality in Australia.
“That is usually the thing that causes the market to reassess banks. Valuations certainly come into consideration, but they are rarely the sole catalyst: you need something else to trigger it … timing is always the issue. The trigger could be tomorrow or next year.”
Still, there are reasons to think CBA will continue to outperform its rivals, whatever happens to the broader banking sector. Barrenjoey analyst Jon Mott invoked a comparison with JPMorgan, suggesting both had become investors’ favourite banks in their respective markets.
