Are Banks a Buy?

Even though it won’t be released until after the market closes today, all the focus will be on the Hayne report and the banks it seeks to reign in. From The Australian:

Australia’s banks are bracing for the biggest overhaul of their operations in generations, with royal commissioner Kenneth Hayne’s report into financial industry misconduct expected today to ­propose civil and criminal prosecutions for rogue companies and executives and tougher watchdog oversight.

Leading corporate titans have called for an overhaul of conflicted remuneration, clearer and more enforceable laws, and a commitment to take responsibility for misconduct.

The government got its hands on the report (the result of a royal commission it desperately tried to prevent) on Friday, giving it the weekend to come up with an appropriate media spin strategy on its recommendations.

There are two related questions for us to ponder today: one as investors, the other as concerned citizens.

Is there a buying opportunity in the largest sector on the ASX?

The question for investors is simple. That is, is all the bad news and negativity from the sector already priced in? Is there a buying opportunity brewing in the largest and most protected sector on the ASX?

Let’s take a look at the financials index…

financials index 4-02-19

Source: Optuma

[Click to open in a new window]

The Hayne inquiry got underway in February 2018. Since then, the index is down around 16.5%. That loss is partly due to fundamental reasons (slowing credit growth — brought about by the inquiry) and partly due to sentiment.

The chart tells you that the sector is still in a strong downward trend. While it rallied in January along with the rest of the market, over the past few weeks the selling has returned, while the broader market has held up.

In fact, it’s worth pointing out that the financials index has underperformed the ASX 200 by nearly 12 percentage points over the past 12 months. That’s massive. Will it continue though?

What to expect

You’ll get a good idea of the answer to that question when the market opens tomorrow. As I said, the report will be made public after the market closes today. That gives investors a good amount of time to assess it and place their bets for Tuesday’s trading session.

If bank stocks rally (or outperform the market), that’s important information for you to know. It tells you that the preceding share price falls factored in all the negativity from the inquiry.

While one trading day doesn’t make a trend, if the index can put in a ‘higher low’ (above the sharp low made in December) it will be a positive sign and indicate bank stocks could be in the process of forming a bottom.

But if the release of the Hayne report results in further selling, it tells you that the recommendations contained within will continue to cause pain for the sector.

Either way, for the contrarian investor, the banks are certainly worth keeping an eye on here for a buying opportunity. While there are a lot of headwinds for the sector right now, keep in mind banks are the most protected species in corporate Australia.

The big four’s core banking operations are protected from competition and their product — money (or credit, or debt) costs nothing to produce. Their ability to create money from nothing is a privilege granted to them via a banking licence.

The limited number of licences (which prevents competition) means banks operate in an effective oligopoly. And while we are encouraged to think of dodgy Russian businessmen as oligarch’s, we don’t refer to our banking CEO’s as such. Perhaps we should.

The provision of credit is a social good. Banks (and the community and government) only seem to realise this at the top of the cycle. Hence the Hayne Inquiry.

This brings us to our second question for today. As concerned citizens, what should we make of all this. Sadly, history points to this being a top of the cycle show that won’t have long lasting effects.

Consider that in 1912 in the US, you had the ‘Pujo Hearings’, named after Democrat senator Arsene Pujo, and headed by lead prosecutor Samuel Untermeyer. Nomi Prins, in All the Presidents’ Bankers, writes that the investigation ‘focused on bankers’ manipulation of markets and stocks, and the negative implications on the entire country of such a concentration of power and influence within the inner group of bankers.

All the big bankers were brought before the hearings and ‘grilled’ — JP Morgan, Paul Warburg, James Stillman and Benjamin Strong, among others. William Rockefeller was, apparently, too ill to say much.

The bankers were too powerful for the hearings to have any real effect. A year later, the Federal Reserve came into existence, the ultimate protector of the big banks.

The desire of the Fed to interfere with the business cycle eventually led to the 1920s boom and bust. It resulted in The Great Depression. The social outrage caused by the depression led to the Pecora Hearings. This resulted in legislation that helped curb bad bank behaviour for years.

But starting in the 1980s and ending with Bill Clinton when he repealed the Glass-Stegall Act in 1999 (which had, for years, separated commercial banking and investment banking operations) the regulatory environment strongly favours the banks again. This wind back of regulation soon led to the credit crisis of 2008. Not surprisingly, this was the worst financial meltdown since the depression.

So while you might see some recommended punishments and changes meted out by the Hayne report, don’t expect structural reform of the banking sector. The banking system is too powerful and too integral to our credit based economy to have major structural changes imposed.

Tomorrow, I’ll discuss what a few of these changes could be. It would make our economy a much stronger one over the longer term.

For now though, I’ll keep an eye on the sector for a buying opportunity. We could be close to an important turning point for the banks…


Greg Canavan,
Editor, The Rum Rebellion

Greg Canavan approaches the investment world with an ‘ignorance is bliss’ philosophy. In a world where all the information is just a click away at all times, Greg believes we ingest too much of it. As a result, we forget how to think for ourselves, and let other people’s thoughts cloud our own.

Or worse, we only seek out the voices who are confirming our biases and narrowminded views of the truth. Either situation is not ideal. With regards to investing, this makes us follow the masses rather than our own gut instincts.

At The Rum Rebellion, fake news and unethical political persuasion are not in the least bit tolerated. It denounces the heavy amount of government influence which the public accommodates.

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