Can this banks rally last?

Major bank share price performance has surprised to the upside in the past year. For the rolling 12 months to 23 September 2024, the total return (share price increase plus dividends) for ANZ has been +34%, CBA +47%, NAB +43% and WBC+67%, all outperforming the S&P/ ASX 200 benchmark considerably (+20.5%). This outperformance has been contrary to our expectations, given that we have not had a Positive recommendation on any of the ‘big 4’ banks.

We are not alone when it comes to concerns about the valuations of the major banks, with Commonwealth Bank in particular defying expectations of ‘sell side’ analysts. According to FactSet data, 13 of the 16 analysts covering CBA have a negative view, while only one analyst has a positive recommendation. This level of negative consensus is extremely rare, evidenced by average sell-side price target which is currently ~40% below the share price.

So why has the sell-side analyst community got this wrong in recent times? Arguably, there have been several ‘top-down’ themes acting as tailwinds for the Big 4 banks, driving share prices higher in spite of ‘bottom-up’ fundamentals.

These include:

• Passive Management: Higher use of passive/ index funds (i.e., ETFs) is driving money towards large index constituents such as CBA (9.5% of the S&P/ASX 200 benchmark), NAB (4.9%), WBC (4.7%), and ANZ (3.9%).
• Institutional Allocations: Government mandated performance tests mean that super funds’ portfolios are now run with a lower risk appetite, driving a move to be around market weight in banks where previously they might have been underweight.
• Risk Reduction: Strong negative views on Chinese equities have driven benchmark aware investors in the region to increase their weightings in Australia to offset risk. Given the desire for domestic exposure, these flows have favoured the Big 4 banks relative to ‘China proxies’ like BHP.
• Rebalancing: The strong outperformance of the banks has forced local active fund managers to manage risk and reduce their underweight positions.

Earnings revisions in recent months have been stable to positive in the banking sector. These have been helped by
abnormally low bad debt costs given low unemployment, the residual benefits of the significant economic stimuli and the impact of share buybacks given comfortable capital levels. Despite this, we think longer term investors should be focused on full valuation levels, the lack of dividend growth in FY25e and FY26e and the risk that benign credit conditions worsen and generate downside risk to earnings and dividend estimates.

Bank Sector Dividend Growth Forecasts

Whilst we acknowledge that the Big 4 banks have been the bedrock of domestic investors’ portfolios for decades, we currently see greater relative value in increasing exposure to interest rate securities, particularly floating rate credit opportunities. For investors seeking income from their Australian equity allocation, we see greater total return potential in APA, ARF, QAN & TLS, all of which are on our E&P Direct Equity Recommendations list.

Bank Sector Dividend Yields vs 10 Year Median