Cash is not so bad

Founder and Chief Investment Officer of Montgomery Investment Management
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If you are of a certain vintage, you may have enjoyed watching the antics of Wylie.E.Coyote and his attempts to catch and eat Road Runner. In almost every episode there was a moment, commonly referred to the W.E Coyote moment, where the disingenuous coyote found himself momentarily suspended in thin air, invariably above a canyon, held up only by an initial failure to realize there was nothing underneath him.

Yield hungry, bank share investors found themselves in just such a situation earlier this year. With term deposits yielding little and forced to move up the risk spectrum, investors purchased bank shares pushing them up while failing to realize that rising share prices need to be supported by earnings growth in order to be sustained. Without commensurate earnings growth, shares chased for yield would give up gains supported by nothing but thin air.

Banks need to retain profits in order to build capital against which they might lend. High dividend payout ratios must come at the expense of retained profits and when combined with the higher capital requirements and mortgage risk weighting ratios recommended by the Financial System Inquiry and imposed by APRA, growth for bank earnings was always going to be a little harder to come by in the future than in the past.

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