Banks in the Balance

Well, this is interesting. Just when everyone is wondering whether the big four banks are a buy or a sell, out comes Trevor Sykes with his take. NAB is a buy, according to an article in the Australian Financial Review this morning.

If you don’t know the name, Trevor Sykes has been covering finance and markets for decades. Now, I’m not one to give much weight to opinions. But Sykes knows his banking history. In fact, he wrote the book about Australian financial collapses (literally).

Sykes says,

My best guess is that low interest rates are not going to rise much any time soon, which means p/e multiples will stay higher than usual. In such an environment, blue chip companies offering attractive yields will continue to be good investments.

‘A serious break in the Australian housing market might hurt the banks a bit, but they all seem well provided against that risk.’

That’s pretty unequivocal considering the general vibe at the moment. Seeing the recent dramatic falls in the Australian banks, particularly CBA, some are calling that the halcyon days of the banks are over. Banks seem to be vulnerable.

It always comes back to Australian housing with them. A lot of people get worried because house price to income ratios are at alarmingly unaffordable levels.

An Australian recession could trigger a sharp correction in the housing market, causing a real threat to the banks. Here’s the thing: that income ratio statistic is totally redundant. It’s pointless to compare one wage to house prices in a meaningful way. That’s because, for the majority of buyers, two incomes are bidding on the properties. House prices rise to reflect this.

Now, don’t get me wrong. If you’re single, you’re in trouble to afford a house if you earn an average wage. But that’s the nature of the system we live in.

At Cycles, Trends and Forecasts we’ve just finished updating some of the indicators we track. They confront some of these concerns directly.

The days of dad going off to work while mum tended to the house and kids are long gone. The data we collect combines household income, and this suggests housing hasn’t become unaffordable at all.

In fact, affordability has done nothing but hover around a ratio of 3.5 for the last fourteen years. In other words, it takes roughly three and a half years household salary to buy the median house. For the last fourteen years house prices have simply kept pace with combined household income. This is not suggesting alarming or unaffordable levels. You can see this indicator and many more by starting here.

Of course, you might be staying out of the property or share market because you’re worried about a recession or collapse either here or in the US.

Another of the indicators we track suggests that a recession in 2015 is highly unlikely. Take the fed funds rate over in the US. This is the rate the US Fed targets to set monetary policy.

When that rate has been so low compared to the longer term 10 year Treasury yield, a recession has never occurred in history. Never. A recession now whilst interest rates are so low is most unlikely.

We look to the US for this, as Australia is too small to create its own cycle and has historically simply followed the US in and out of recession.

So let’s get back to those banks. The recent fall in the CBA share price is not unprecedented or out of the ordinary. Stocks do not go up in straight lines. They do retrace and consolidate gains. Bank stocks are no exception. I expect this month will be a solid low for the bank.

Now, in analysing CBA, this where some knowledge of the real estate cycle is crucial. As we know, banks are intimately tied to real estate.

The economy simply repeats in a time frame of roughly 18-20 year segments. This current property cycle looks to be no different. So far the cycle’s repeated in line with our 18-year real estate clock.

Very few analyse bank stocks in this way and this is your advantage over everyone else.

Around 1996 and 1997 would be the equivalent time to look at for a point of comparison. What occurred to CBA share price back then?

In 1996 we saw an even bigger fall than what we recently witnessed. Check it out…

CBA daily chart 1996


CBA

Source: STEX

Click to enlarge

In 1997, an even bigger fall again.

CBA daily chart 1997


CBA

Source: STEX

Click to enlarge

Now look at those events in the context of the 18 year real estate cycle below.

CBA monthly chart


CBA

Source: STEX

Click to enlarge

Can you see how the dramatic events of ’96 and ’97 marked by the arrows simply do not register in terms of the greater 18 year real estate cycle?

This knowledge is your investment advantage, no one else does this, looking at the economy in this way. This stock is strongly tied to the real estate cycle and this cycle is just getting underway, we have a long way to go yet. To assist your share market investing, you can learn more about the cycle here.

But you actually don’t need to form an opinion on CBA, whether good, bad or otherwise, or listen to mine. For the market will tell you.

In the context of where we are in the cycle, the monthly low on the chart from the previous year must hold. If it does, CBA could go into your watch list. So that is something we can all watch. For now, we just have to wait and see.

Regards,

Terence Duffy,
For Markets and Money

PS: A new cycle is turning for the Australian economy. Markets and Money editor Greg Canavan calls it a ‘Golden Age’. As you’ll see in the next few days, China is working full-steam-ahead to bankroll the biggest wave of infrastructure spending you’ll probably witness in your lifetime. Joe Hockey’s budget announcement last week signalled the government sees what’s coming. And for investors, understanding this opportunity — and buying great value stocks to play it — could prove to be the smartest investments of the decade. Greg will deliver a full report on this breaking story for you this Saturday, May 23.


Terence Duffy is an analyst and chartist, specialising in researching economic trends and cycles.  His primary focus is housing and land affordability. But you can also depend on him to offer his unique analysis of stock market charts. As Terence will show you, the charts often forecast, well in advance, the good or bad news to come — which he details in Cycles, Trends and Forecasts.


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