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Should you sell your shares in Australia’s big four banks?

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Credit: Thomas Kohler

Investors have a love-hate relationship with Australia’s big four banks, irrationally dumping them when their outlook becomes uncertain, but piling back in just before dividend season to capitalise on their market-leading dividend yields. With Australia and New Zealand Banking Group Limited (ASX: ANZ), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corporation (ASX: WBC) all slated to announce full-year results in May, I believe it’s time to revisit the big four banks following calls to short sell the lot.

Housing market

According to reports in the Fairfax Press, doomsayers predict that Australia’s housing market is on the verge of collapse, with current house prices being touted as unsustainable in today’s economic environment. As a result investments banks are betting against Australia’s property market by opting to “short” Australia’s big four banks, given their leverage to the housing market (through their loan books).

By way of background, short selling is the process of selling a borrowed security with the intention of buying it back at a lower price. The trade is based on the assumption that a company’s share price will fall, hence profiting from any difference between the buy and sell price. Short selling Australian banks is colloquially known as the “widow maker trade”, given the strategy to short banks has proven unsuccessful many times in the past. However, recent figures from The AFR reveal that short interest in Australia’s big four banks has climbed to a record $8 billion, accounting for 3% of their combined share float.

Interestingly, Commonwealth Bank of Australia (ASX: CBA) has recorded the highest increase in short positions out of the big four banks, assumedly because it holds the largest home loan book in Australia. Whether this implies the trade is likely to succeed this time around, or that too many people have been watching The Big Short movie is yet to be seen. Nonetheless, as a long-term investor myself, I definitely won’t be following the naysayers to short the banks, and instead will take this opportunity to buy some more.

Industry outlook

Despite the doomsday prophecies for Australia’s housing market, the banking industry outlook appears quite robust. In recent trading updates provided during February, each of the big four banks reported better-than-expected results, demonstrating resilient earnings in the wake of slowing global growth. Whilst return on equity was down across the board, mainly due to the Australian Prudential Regulatory Authority’s (APRA) requirement to hold higher levels of equity, reported cash profits were consistently higher from each of the big four banks.

A lingering concern for each bank is further changes to regulatory requirements by APRA; nevertheless, the recent updates demonstrate that the big four banks are well poised to navigate these obstacles as they continue to churn out profits.

Foolish takeaway

In light of the benign industry outlook, I believe the bank to bet on at current prices is NAB. Whilst trading on a fully-franked trailing yield of 7.1% and a price to earnings just a bit over 11, I believe NAB is under-priced compared to its peers. Although ANZ, CBA and Westpac appear to have equally sound prospects, NAB’s recent demerger of its Clydesdale and Yorkshire Banking Group (ASX: CYB) and higher reported net interest margin – a precursor to profitability – should provide a boost to full-year results.

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Motley Fool contributor Rachit Dudhwala owns shares of Australia and New Zealand Banking Group,  National Australia Bank Limited and Westpac Banking Corporation. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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