Our updates, free in your inbox:

or click here to talk to us about securing a better financial future

Hybrids – Watch Out

Investing in bank shares has been an easy, default trade for so long that it hasn’t warranted any serious debate, until now.

Understandably, most portfolios would be reluctant to part with large chunks of bank shares purchased at much lower levels over many years that have delivered both capital and income growth par excellence.

But more recently, investors have also lapped up the hybrid issues from the major banks with the same alacrity.

Ejecting these hybrids from your portfolio now might be a sensible move to reduce exposure to a vulnerable and arguably over-priced bank sector.

Also, simply rolling from one issue into the next, such as with the CBA PERLS series, is looking more risky as the premium in these hybrids dissipates. Indeed, this argument applies to non-bank hybrids as well.

Rate hikes to slow down housing

Australian banks could be vulnerable if the RBA decides higher rates are needed to soften the housing market.

Residential mortgages are the backbone of bank profits and with little demand for business credit growth and the loan impairment cycle undoubtedly at its lowest point, bank profit growth could begin to look quite limp. Dividend growth will taper off as a consequence although the yields will still look pretty good.

The ASX Financials Index has already slipped 5% so far this month but the big banks have fared slightly worse.

FSI won’t have a happy ending for big banks

Don’t forget that the Financial Services Inquiry is yet to deliver its findings. The already well-capitalised banks will protest any further need to raise yet more capital although they won’t find it difficult to do so.

Australian investors have become attuned to investing in the retail banks (mostly for the high fully franked income stream) but also for the relative comfort and perceived safety factor. It has become the default investment for many but, to borrow the Treasurer’s phrase, it might be lazy analysis.

A$ heading lower

The balance of evidence suggests the Australian dollar is heading lower, but not in any orderly fashion.

Just as the Chinese Central Bank PBOC is injecting US$81 billion into its five major banks, the Federal Reserve is mulling a change to its rhetoric about how, when and how much it will begin raising interest rates in the US.

‘Tapering’ was the buzzword for 2014 but this has been replaced with talk of tightening by the US Fed.

The whole world seems to be going long the US dollar trade leaving currencies like the Australian dollar potentially vulnerable to a slide.

Not that that is a bad thing, if you are the Reserve Bank of Australia, which would dearly love to see some of the heat come out of the domestic housing market and provide some support for exporters.

It could have other ramifications for the Australian market.

A weaker Chinese economy puts downward pressure on bulk commodity prices such as iron ore and coal and potentially also dampens demand for other key commodities such as copper and aluminium.

The Australian dollar is well known as a commodity currency so the implications would mean more downward pressure in this scenario.

RIO and FMG are the most exposed iron ore producers but both have large, low cost businesses that will withstand lower prices and remain profitable throughout. BHP also produces a fair bit of the stuff but is more diversified across other commodities, especially oil and gas.

Leave a Reply

Your email address will not be published. Required fields are marked *