Be brave – dump the banks

Only the brave and the foolish suggest investors sell the banks. You can work out which one I might be over the next few hundred words.

I get all the arguments about why you should continue to hold them.

Despite anaemic credit growth retarding revenue, by managing their profit margins, cutting staff, sending jobs offshore and reducing bad-debt provisions, the banks should be able to increase earnings and dividends.

And the Australian economy is healthy, at least by global standards, with room to lower interest rates if things get tricky. The banks have also reduced their reliance on overseas funding, while keeping their capital ratios in check. Plus they have pricing power in a huge market.

And where else can you get a reliable and growing 6 per cent, fully franked dividend yield from a regulated oligopoly that would be saved by the government in a crisis?

There’s no argument, right? If only life were that simple.

To overseas investors, our banking sector and the Aussie dollar is the next big short (where you profit from the price of an asset falling). Residential property prices and our exposure to a bursting Chinese credit bubble offer them plenty of encouragement.

The argument for selling has also been bolstered by the resilience of bank stock prices despite a raft of negative economic data.

Eighteen months ago we were suggesting investors reduce their weightings to bank shares because of the risk of a slowdown in China and the potential consequences for the Australian economy. Today that is no longer a risk. It’s a reality.

More than $150 billion of resources projects were cancelled in the four months to April. And the Roy Morgan unemployment survey suggests the true unemployment rate was 10.9 per cent in February, up from 9.7 per cent a year earlier.

Meanwhile, we approach the mining cliff. BIS Shrapnel economist Adrian Hart is expecting major project work in Queensland to fall 40 per cent over the next five years as LNG projects in Gladstone are completed and the coal industry continues to struggle.

With Victoria, South Australia, Northern Territory and Tasmania already in recession, it’s hard to imagine the banks won’t eventually feel the impact. And yet bank share prices are up significantly over the past six months.

In summary, the economy is likely to slow (at best), the banks have a large exposure to mortgages, Australian consumer debt levels are very high by historical standards and bad debts are at or near record lows.

The upside from here seems limited. So this is a call to ask yourself whether you’re overexposed to the big banks. Here are four tips to help you answer that question:

1. You don’t need to own the banks

Forget the uniquely Australian notion that you need to own the banks. You don’t need to own anything. There are plenty of companies that aren’t highly leveraged, don’t face the same risks as banks and would benefit from a lower Aussie dollar. Banks aren’t essential to a high-performing portfolio.

2. Don’t anchor on higher prices

If you have 10 per cent or less invested in the banking sector then you have very little to fear. (Intelligent Investor Share Advisor’s recommended portfolio limit of 20 per cent doesn’t take valuation into account.) But if the big banks form more of your portfolio than that, don’t let their current high prices and attractive dividend yields prevent you from acting.

3. Keep it simple and avoid emotional attachment

Ask yourself whether, at current prices, you are being compensated for the risks of holding the banks? If not, then it’s time to sell down.

And try to avoid becoming emotionally attached to your stocks. A study by Dan Ariely, author of Predictably Irrational, found that we overvalue things we own. One way to counter this is to imagine you were building a portfolio from scratch today. Would it look the same as the one you own now?

4. Don’t let tax get in the way

Don’t let paying capital gains tax stop you from acting in your best interests. Better to pay the taxman and pat yourself on the back for a great investment than risk getting greedy and suffering unnecessary losses.

If your portfolio is unbalanced and you’ve enjoyed a great run with the banks, now could be a good time to lock in some profits and either wait for better opportunities, or pay a cheap or fair price for other income stocks.

This article contains general investment advice only (under AFSL 282288).

Nathan Bell is the research director at Intelligent Investor Share Advisor. You can get access to a free trial and a special end of financial year offer that includes four special reports at shares.intelligentinvestor杭州夜网

The original release of this article first appeared on the website of Hangzhou Night Net.

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