Are Australia’s Banks Going Bust in a Loud Boom? All of the Signs Point That Way!

As 2016 drew to a close, even as US bank stocks posted some of the biggest gains since Mr. Trump got elected, it seemed their counterparts down-under aren’t doing that well! All signs point to a huge weakening in Aussie bank stocks in 2017. But the bigger question is: Will we hear a loud boom as banks down under go bust?

THE OMINOUS SIGNS

There are ominous performance lags in Australia’s premier stock index, the S&P ASX/200 (AS51:IND), when compared to the  iShares MSCI ACWI ex-US ETF (ACWX:US). If you plot the two over a graph and analyse performance over a 5-year period, you can clearly see that they are moving in harmony – not necessarily in convergence, but definitely in the same direction. 

These lock-step moves indicated that there was a strong co-relationship between the two comparators. The equity market down under seemed to be working in tandem with most of the world. All was well until now!

A shorter term (1-year) view of these same two comparators reveals a whole new story, however. While the lock-step journey continued until around mid-December 2016, with the AS51:IND even outperforming the ACWX:US for a brief while; all that came to an abrupt end by mid-January 2017. There now appears a clear divergence, with the AS51:IND racking up a -26.88 differential as of the time of this writing.

The tight co-relation between the ASX and the rest of the world is clearly decoupling!

THE UNDERLYING CAUSES

The underlying causes for this apparent divergence can be summed up in two words: Australia’s banks!

Australia’s financials index (AXFJ), which comprises over a 3rd of the ASX 200, had been ticking along merrily over the last 1 year or so, gaining a healthy 12.22%. This lead the broader S&P/ASX 200 to a nearly 13% gain during the 1-year period.  However, since the beginning of 2017, the ASX 200 is down nearly 1.94% (at the time of this writing), largely on a 3.55% decline of its financials component.

Analysts are convinced that the Australian Banks are largely responsible for the dismal YTD performance of the broader benchmark; and yet again there’s a 2-word explanation for the underlying cause: Interest rates.

The US banks continue to deliver steady improvements in their performance, largely driven by the gradually improving US economy, and powered by the recent Fed rate increases. The prospect of an additional two (for sure), and probably three increases over the next 12 months is also putting wind in the sails of the US banks.

With Australian banks however, it’s a whole different ballgame!

With no imminent Australian central bank rate increases in sight – the odds are just 15% that there will be even a single hike, the spreads between borrowing and lending rates are compressing even further. This is then putting huge pressure on profitability and future outlook for growth in bank stocks. 

Because of the comparatively lower premium (compared to U.S Treasuries) offered by Australian debt instruments, it would appear that the financial sector in Australia could be destined for darker times.  

The Australian stock market is clearly diverging from its previous charted course in line with broader global equity markets. Leading the downward spiral are Australia’s banks. The question is: Will the banks go bust with a loud boom? That is the million dollar question!