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Betting on a bank share price crash

Australian banks are way overpriced according to foreign hedge funds, with several moving to short them.

Shorting is a technique that traders use to bet on share prices falling. And the hedge funds are gambling that Australia’s biggest four banks, ANZ Bank (ASX:ANZ), Commonwealth Bank (ASX:CBA), National Australia Bank (ASX:NAB) and Westpac Banking Corporation (ASX:WBC) will see their share prices drop. CLSA analyst Brian Johnson has told the Australian Financial Review that the bearishness by foreign investors towards the banks is significant as offshore investors have been the incremental buyer for the last two years as they chased dividend yields.

The market cap of the Australian banks has jumped from just 2% of the global banking index to 14% over the past ten years, according to Bank of America Merrill Lynch strategist Michael Hartnett. The big four banks between them now represent 30% of the S&P/ASX 200 Index (Index:^AXJO) (ASX:XJO),  while in May, UBS analysts said the Commonwealth Bank was the most expensive bank in the world by nearly every standard valuation measure.

As Mr. Hartnett told an investment conference last week in New York, “There are a number of hedge funds that are short the Australian banks right now, trying to play on that demise of the emerging markets.” A slowdown in China would hurt Australia’s economy and the banks would be in the forefront. Heavy exposure to Australia’s property market leaves the banks vulnerable to a property price crash.

Foolish takeaway

Locally, Mum and Dad investors searching for high dividends have also been dumping their cash into the banks, thanks to their high yields and supposed ‘safe’ blue-chip status and adding to the view that banks share prices are in ‘bubble territory’. But banks are highly-leveraged businesses and any downturn in Australia’s economy could see their profits slammed and dividends slashed. Because Australia hasn’t seen a recession for more than two decades, many investors seem to think that bank shares can only go up in value. They could be about to learn an expensive lesson.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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