In September 2015 I wrote a report that gave a fund manager friend of mine a good laugh.
He paid out on me with comments like ‘you will write anything to get a headline.’
His laughter was coming at my expense.
‘Five Fatal Stocks You Must Sell Now’.
What were the fatal five?
‘My recommendation is to sell the big four banks (CBA, ANZ, WBC, NAB) because of the risk of a market correction taking down their expensive valuations. I include BHP in the top five to sell as well.’
Why was this so hilarious at the time? The Big Four banks and Telstra were the go-to stocks for investors seeking yield.
How did that recommendation pan out?
The four banks are into the negative. BHP is the only positive. And just for the record, Telstra is down almost 50%.
Source: Yahoo! Finance
In table form, the five-year performance figures look like this…
On an equal weighting basis, the fatal five are underwater to the tune of 13%.
Add back dividends (of even 6% per annum), the total gain over that time is around 17%.
That’s a little over 3% per annum.
Over the same period, term deposits have only slightly lagged this performance.
But there’s one big — no — make that HUGE difference.
The combined value of the share portfolio is now 87 cents in the dollar AND dividends are being cut.
Are these dividend cuts temporary or more permanent?
Should you sell and take the 87 cents in the dollar now or do you wait and see if the shares recover in value?
These are not questions that someone with their capital in a term deposit has to ponder.
Their mind is free of these encumbrances.
The holder of the term deposit still has 100 cents in the dollar and interest (albeit at a measly 1%) is being paid.
Whether they realise it or not, shareholders in the Big Four are facing enormous pressure in the coming years.
That pressure is twofold
Firstly, there’s the impact of a looming negative rate environment.
I know the RBA has said taking rates below the zero line is ‘extraordinarily unlikely’. But what Dr Lowe did NOT say is this will never happen.
As sure as night follows day, when the next dumpster load of the proverbial hits the fan, interest rates will have a MINUS handle in front of them.
That’s what central bankers are programmed to do. Cut rates and print money.
While negative rates are not good news for deposit holders, they are even worse for bank shareholders.
That’s been the experience in Japan and Europe.
From a 2006 high of ¥470, Japan’s banking index has fallen around 80% to…¥100.
Similar story in Europe.
From a high of €488 in late 2007, the Euro Stoxx Banks Index has fallen to a recent low of €51…a 90% fall in value.
Source: Euro Stoxx
Banks cannot make enough margin in a world of negative rates.
This article written by Ambrose Evans-Pritchard, was published in the 13 October 2020 edition of the UK Telegraph:
Source: UK Telegraph
Here’s an excerpt (emphasis added):
‘A paper last month for the San Francisco Fed issued a withering verdict on Europe’s experiment. “Both bank profitability and bank lending activity erode more the longer such negative policy rates continue,” it said. Its review of 5,300 banks found that there may be an initial bounce but then “lending declines over the next two years, more than reversing any initial gains. As negative rates persist, they drag on bank profitability even more.”’
Eroding bank profitability is not good for those expecting share price growth and an increased dividend stream.
Secondly, banks are under attack from the fintech sector.
According to a report published by Wharton University (emphasis added):
‘Fintechs are growing rapidly. Their range of offerings and number of customers are expanding as they target the pain points that clients experience with traditional banks.
‘…four years ago, fintechs [accounted for] probably 5% of the market for personal loans. Today, more than 45% of personal loans are originating through fintechs. It’s clear that a shift has taken place, and fintechs are gaining more momentum.’
Banks are under attack from all angles…not to mention complying with government dictates to be good corporate citizens.
Fintechs have a distinct cost advantage over the traditional banks. No branch networks and (much) less staff.
The annual expense of maintaining a client account for a fintech is a fraction of what it costs the ‘brick-and-mortar’ banks.
The need to pare back overheads partly explains why, on 16 September 2020, Bloomberg reported (emphasis added):
‘Job losses at banks this year are on course to be the deepest in half a decade. After a pause during lockdown, lenders from Citigroup to HSBC Holdings have restarted cuts, taking gross losses announced this year to a combined 63,785 jobs, according to a Bloomberg analysis of filings. That puts the industry on track to exceed the almost 80,000 disclosed last year, the biggest retrenchment since 2015.’
The coming fintech assault…
Removing staff and ramping up technology is the only way banks can remain competitive.
Australian banks are not isolated from what’s happening beyond our shores.
As fintech systems and processes are tried, tested and tweaked in China, the US and Europe, they are destined to be rolled out Down Under.
The coming fintech assault will be similar to what we’ve seen with free-to-air TV. The once dominant networks have lost ground (and advertising pricing power) to a host of online entertainment options.
The aforementioned performance numbers are AFTER the Fed’s artificially-created market recovery.
Here’s what those numbers looked like for the Big Four in late March 2020:
Source: Yahoo! Finance
The performance data was a whole lot uglier back then…
Even if you added back dividends, holding bank shares from September 2015 to March 2020 was a losing proposition.
When the next market rout happens, these numbers (and possibly worst) are likely to be revisited…and to rub a little more salt into the wound, expect there to be further dividend cuts.
For my fund manager friend this is no longer a laughing matter.
Editor, The Rum Rebellion