Australian Stock Market to Murray…Meh

A quick follow up on the release of yesterday’s Financial Services Inquiry. Of the many recommendations made, most centred on the need for the big banks to raise more capital and the levelling of the playing field between the big four and the second tier banks.

Well, whatever was in the report, the market didn’t see it that way. The big four bank stocks soared yesterday. Bank of Queensland [ASX:BOQ] meanwhile, fell nearly 2% and Bendigo and Adelaide Bank [ASX:BEN] fell 0.15%…although it is near record highs.

In other words, the market doesn’t believe the report’s recommendations will actually have much effect on the sector, or if so, it was already priced in. The general gist is that market fears of future capital raisings are overblown. The thinking goes that banks generate excess ‘organic’ capital (a nice little euphemism for high profits) and can therefore use these strong profits to boost capital levels as needed, rather than go to the market for extra capital.

The other issue is that the reforms still need to be implemented, a responsibility the government has put onto the bank regulator APRA. This means any change will likely take years, giving the banks plenty of time to adjust.

In the meantime, there’s an interest rate rise on the horizon. This is ‘great’ for the banks…but not so great for the economy as a whole, because the increase in debt levels that it fosters just adds to the underlying — and unseen — risk in the financial system.

David Murray’s recommendations seek to fundamentally change the structure of the financial system and attempt to place the burden of financial risk taking back on the bankers (and off the taxpayers — you and me).

That the market doesn’t seem to care or give due weight to the recommendations says a lot about either the ignorance or the arrogance of the market, brought about by years of ‘success’ and really believing that Australia has one of the strongest financial systems in the world.

No, we don’t. Our banks are just as leveraged and risky as any other banking system. It just depends on the risk they face. David Murray correctly points out that when the next crisis hits (and it will) there will be no mining boom to bail us out as it did in 2008/09. He knows that things will be much worse.

But as is the nature of financial crises, those providing the warnings and trying to prepare the system for stress are often ignored. The bankers simply don’t care about downside risks because they have no incentive to care.

So what if things go bad and it turns out the banks don’t have enough capital? They have the implicit backing of the Reserve Bank of Australia and the government (the taxpayer…you and me), and so their downside is limited.

But the upside? It’s all theirs. We don’t get to share in it in any way…we are only there for downside protection.

It’s this ‘asymmetry’ (all upside, limited downside) that David Murray wants to address. Will he be successful? It will be a long road, but it’s early days. So far, the market says the banks are still untouchable.

Regards,

Greg Canavan+
For Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

 


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