The bank yield plays will keep yielding

Founder and Publisher of the Switzer Report
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There’s a whole lot of bank bashing around at the moment but it does depend on who you are. If you’re a wealth accumulator, you might be a bank seller but you’ll have to work out your profit versus your capital gains tax implication.

However, if you’re a bank buyer for the dividends primarily and have been happy to collect the capital gain, then you might just as well cop the dive in share prices and buy again when they get even lower (read James Dunn’s article today for an analysis of the financials of the big four).

The future for banks

I say this because I reckon bank share prices will recover but they might not go as high as you would hope.

The very smart Charlie Aitken in this Report put together a very thoughtful case of why he went to “neutral or hold” on banks in April and now has gone underweight.

In a nutshell, the US interest rates are set to rise and the Fed will be halting money supply increases with the end of QE3, which will push up the greenback and lower the Australian dollar.

It’s why our stock market has been falling with the dollar and it’s because foreigners, who chased yield stocks, are now selling out. Taking their money home if you like and they might buy US bonds instead.

They are also fearful of holding Aussie shares, which will be less valuable when they sell out of them and convert the dough into US dollars. The longer they wait, the greater the amounts they could lose.

Charlie says foreigners don’t get franking credit benefits and so they are less addicted to our yield stocks. But he did accept that they might return one day when they think the dollar has hit rock bottom.

Why would they return to our banks? Because they are damn good investments backed by a government guarantee that some nutcases want to take away! I really hope David Murray, who is a mate, doesn’t buy this bull dust.

We survived the GFC without a recession and 10% unemployment because the ratings agencies saw our banks as some of the safest in the world. It kept our borrowing costs down, and it still does, and in part explains why we have an economy that has avoided a recession for 23 years.

Canada is toying with changing its government backing of its banks and the debt rating agencies are thinking about downgrading them.

In a recent SMH article, the Macquarie analyst Mike Wiblin said “a credit rating downgrade would push up the cost of Australian banks’ borrowing overseas, inflicting a hit to earnings of between 3% and 5%.”

This is why I hope David ignores the ‘experts’, who don’t like the banks being backed by the government. My argument is that the government support means lower interest rates, more growth, more jobs, more confidence and if it ain’t broke, why fix it?

And given the benefits, it’s one of the reasons why I think our big banks remain a good investment, especially at lower prices.

The advantages

I think our economy is getting better. Eventually, interest rates will rise and that does not hurt bank profits. They are such monoliths in our economy, I just can’t see them screwing up their advantages.

Only 11 months ago, Morningstar said this of our banks: “Australia’s largest four banks dominate an oligopoly that gives them a durable structural competitive advantage, ensuring they’ll earn excess returns over the very long term. This enables the banks to prosper compared with major banks elsewhere in the world and gives Morningstar’s analysts confidence that the banks will have global sector-leading returns on equity for the foreseeable future.”

Morningstar said the banks have an “economic moat”, which is a “sustainable competitive advantage that allows a firm to generate positive economic profits for the benefit of its owners for an extended period of time.”

What advantages? Try scale advantages, cost advantages, efficiency advantages, investment advantages, capital advantages, funding advantages and competitive advantages. Oh yes, government support advantages.

In only February, the SMH reported that: “Australia’s banking sector has been rated one of the five safest in the world as profits soar and bad debts decline.”

But there was more.

“We believe that Australia is currently one of the five least-risky banking systems of the 86 for which Standard & Poor’s has published banking industry country risk assessments,” S&P credit analyst Gavin Gunning said.

“Our most likely scenario for 2014 is that it will be a year of continuing investment-grade ratings resilience.”

The other safe places to bank were Switzerland, Canada, Germany and Hong Kong.

All this tells me that, provided the world economy does OK (the G20 finance ministers last weekend said they’re trying to push up global growth by 2% over five years) and our economy grows stronger (which I expect), I think banks remain an OK investment.

What I’m doing

When it comes to my own investments, I play a more steady accumulation game based on yield. I don’t care if my capital fluctuates because it eventually comes back. If I really can see a crash coming, I’d cash out. Of course, that’s not always easy to spot, though I’m permanently on crash alert. That’s my gig at the Switzer Super Report.

The other part of my gig is to spot value for yield players. Banks at lower share prices, which will eventually go higher when foreign investors return, look like an OK play and I’ll be playing it!

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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