Here’s why you shouldn’t bank on the big four banks for capital gains

Investors have pocketed enormous profits from the big four banks over the last couple of years.

Not only have they delivered market-blitzing capital gains, their fully franked dividends have also been extremely rewarding in an otherwise low interest rate environment.

But to say that cracks have begun to appear in recent weeks would be a gross understatement.

Since peaking at an all-time high $83.92 in July, Commonwealth Bank of Australia (ASX: CBA) has crashed 10.9%, wiping billions of dollars from its market value. Although their downturns haven’t been quite as sharp, National Australia Bank Ltd. (ASX: NAB), Australia and New Zealand Banking Group (ASX: ANZ) and Westpac Banking Corp (ASX: WBC) have also plummeted more than 10% since their 52-week peaks.

Of course, the banks did grow a huge fan-base during their recent wonder years, so many investors are proclaiming that now is the time to buy!

But I wouldn’t be so sure. In fact, I believe that what we’ve seen over the last few weeks could be just the beginning…

Now I’m not going to go all apocalyptic or start predicting the next great market crash – no way. Instead, I’ll happily go on record as saying that now is still a great time to buy shares – so long as you’re buying the right ones, that is.

I’ll tell you one stock I think is a great buy in a moment, but first, I should state that the banks are still not looking attractive, even at today’s depressed prices. Here are a few reasons why…

Currency and Foreign Investment

It seems that one of the biggest headwinds facing the banks right now is the plunging Aussie dollar. While the dollar has dropped more than 6% compared to the US greenback in the last six weeks, the RBA has still expressed the need for it to fall back to more normalised levels. While some are suggesting that’s around the US80c mark, it could fall even further towards the 20-year average at just US76.6 cents, based on OzForex’s figures.

That would reflect a further downside between 7.9% and 11.8% for the exchange rate. With that kind of potential, foreign investors will not want to be stuck with Aussie investments as the currency drops in value, indicating a further sell-off could be nigh.

Property Market

The RBA is becoming increasingly concerned regarding Australia’s inflated property market. While they do not want to start raising interest rates just yet, there have been discussions regarding whether regulations should be introduced to tighten lending. Westpac and Commonwealth Bank are the most exposed here, given that they are the two most dominant in the mortgage market.

It should also be noted that there is a high likelihood the banks will be required to hold more in capital to protect against a potential economic downturn. This would not only impact the banks’ return on equity but would likely also impact their ability to grow or even maintain dividend payments.

Evaluations and Yields

The banks are still expensive. Sure, they might maintain lower P/E ratios than the average ASX 200 company, but they also have far more limited growth potential over the coming years, making them appear very pricey.

As such, I find it very difficult to imagine how the banks could go on to post market-beating returns over the coming years – even with their dividends. Instead, investors who choose to buy now could actually be committing themselves to years of underperformance.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned. The Motley Fool owns shares in OzForex.

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