Australia's big four banks have played a key role in the share market's recent recovery.
Since the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) bottomed out on Monday last week, Australia's major banks have rallied hard, driving the benchmark index almost 5% higher. National Australia Bank Ltd. (ASX: NAB) has been the biggest winner, rising 7.3% in that time while Commonwealth Bank of Australia (ASX: CBA) has recovered a more modest 5%.
While these recoveries will no doubt entice some investors back onto the scene, the question that really needs to be asked is…
How sustainable are these rallies?
Each of the big four banks have delivered enormous returns to shareholders in recent years – in large part thanks to their solid fully franked dividends in an otherwise low interest rate environment. But somewhere along the way, it seems that investors forgot about the importance of valuation. It also seems that they were too focused on the shares' past performance, as opposed to what the future may hold for the banks.
To steal a quote directly from an article written by Motley Fool investment advisor Scott Phillips this morning…
"if your investment case for the miners, banks (or any other company) are centred on past performance, and doesn't take future growth (and the challenges therein) into account, you're skating on some thin ice."
The truth is, the banks have been amongst Australia's best stocks for an extended period of time. But, like with any stock, there is a time for buying, and a time for waiting on the sidelines and exploring other opportunities.
I'll fill you in on one incredible investment opportunity in just a moment, but first, let me say this…
There are a number of reasons to avoid the banks right now
Aside from their lofty valuations, the banks' ability to grow earnings over the coming years could be very limited. Bad debt charges are already at a record low and unlikely to fall any further while aggressive competition is blanketing the sector and restricting loan growth.
In addition, it's looking highly likely that the banks will be forced to hold more capital in reserve as a result of the Murray Inquiry which will impact their return on equity and could even see their dividends decline.
There's also good reason to be cautious of Australia's red-hot property market. Commonwealth Bank and Westpac Banking Corp (ASX: WBC) both control the biggest portions of Australia's mortgages, and should the so-called 'bubble' burst, shares of both banks could be rammed into the ground.
I will say this, however. Investors are still right on the mark in their pursuit of fully franked dividends. Low interest rates are here to stay for the foreseeable future and buying high-yielding, fully franked dividends is one of the greatest ways to boost your returns.
So here's the incredible investment opportunity that I mentioned before…
