- UBS says Australian banks have under-performed the market for three straight years, based on the measure of relative earnings momentum.
- Analysts David Cassidy and Jim Xu said that trend looks set to continue, as tighter lending standards weigh on margins in a cooling housing market.
Australia’s banks have under-performed the broader market for the last three years running, and UBS expects that trend to continue in 2018.
It marks the longest stretch of under-performance going back to 1990 — a period in which Aussie banks have shown the ability to bounce back relatively quickly from any downturn.
Equities strategist David Cassidy and analyst Jim Xu used a relative earnings momentum measure as the basis of their analysis.
Relative earnings momentum is defined as: the percentage change in the consensus view of a company’s expected earnings per share (EPS) over the next 12 months, compared to the broader market.
The pair said relative EPS momentum “appears to matter more than anything else” when it comes to assessing bank performance.
Of the 13 years in which banks have lagged the market going back to 1990, the sector showed weaker EPS momentum in 10 of them:
Not only have the banks under-performed on that basis over a rolling three-year time frame, bank stocks are also trading at a price-to-earnings discount to the market — a gap which has now reached its widest level since the 2008 financial crisis.
Given that fairly negative backdrop, the analysts posed the question that most investors are probably asking themselves:
“Will this underperformance continue, or is there hope for a revival”?
On that front, the outlook doesn’t look great.
For starters, Cassidy and Xu cited other UBS research in which the bank expects “domestic credit growth to slow sharply”.
It follows announcements by banking regulator APRA in April that it expects banks to introduce stricter in-house standards on debt-to-income ratios for loan approvals.
There’s also the matter of the ongoing banking royal commission, which UBS said “appears to be taking a much more rigorous interpretation of responsible Lending”.
Banks have responded by moving towards more rigorous assessments of loan applications, particularly on the expenses side.
And last week, real estate agents told Business Insider that the effect of those changes is beginning to be felt at the ground level.
Taken in aggregate with respect to bank profits, it “suggests the ability to rebound from the current earnings lull will be very difficult,” Cassidy and Xu said.
That will be the case “even if one subscribes to a ‘soft landing’ scenario for house prices, credit growth and the economy”.
The pair’s estimate of earnings growth for banks in the 2019 financial year is a dismal -1%, against a market consensus of 4% — still less than forecast growth for the ASX200 of 5-6%.
Based on the measure of relative earnings momentum, that suggests the banking sector — which accounts for around 25% of the ASX200 — is unlikely to provide a catalyst for strong returns on the broader market.
Cassidy and Xu said the sector could drive and engineer capital returns that are more in line with the market, by focusing on costs or returning capital to shareholders.
However, “while this is not impossible, it is difficult see over the 2019 financial year at least”.
“While a short term relief rally would not surprise we remain underweight with the typical driver of bank outperformance an earnings re-acceleration likely to prove elusive.”
