Profit or loss for the banks?

Where the banks will go from here is anyone’s guess. Whilst it is fair to say that they currently present as overly expensive stocks, there have been fair arguments suggesting that the falling Aussie dollar will benefit the big four banks. On the other hand, there are opposing views that suggests that, when interest rates begin rise, the banks will lose out.

Analysts have suggested that the banks could gain an additional $223 million combined. UBS analyst Jonathan Mott has increased his forecast earnings for each of the banks, whereby ANZ (ASX: ANZ) would be the beneficiary of an extra $133 million, whilst Westpac (ASX: WBC), Commonwealth Bank (ASX: CBA) and NAB (ASX: NAB) could gain $21 million, $28 million and $41 million, respectively.

Again, there is further debate as to the direction of the dollar. Whilst some have estimated it could fall to around US80c, Westpac economists believe it should stay around US90c for 2014.

However, according to the Deutsche Bank, the banks will begin to lag the market when rates begin to increase. Currently, rates are sitting at an all-time low of 2.75% and are expected to be dropped further to apply additional pressure to the dollar. According to The Australian Financial Review, “the share prices of banks tend to outperform the market in a rate-cutting cycle, and usually for the three months thereafter… But as tightening sets in, this turns into a 12- to 18-month cycle of underperformance”.

Data provided by Deutsche Bank shows that the banks’ average outperformance compared to the market has been 25% in the past five easing cycles – likely due to the low rates causing a pick-up in the housing market and further loans being taken out, leading to higher profitability. Alternatively, as the central bank begins to tighten the cash rate, the banks have typically underperformed resources stocks by 18% for up to two years after the rate cuts.

Foolish takeaway

Despite the recent falls in the banks’ share prices, they are still overpriced compared to their future growth potential. Whether their profitability increases due to the falling dollar or if it decreases when rates begin to climb, it remains unlikely that they will outperform the market in the long-term.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned in this article.

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