The headwinds buffeting the big banks may be easing faster than most had thought.
As shocking as it might sound, the coronavirus is helping lift the fortunes of the sector, while better than expected earnings updates provide early signs that the tide is finally turning for the embattled sector.
This begs the question: is it time to go overweight on the sector?
Let me explain about the virus threat first as many might be scratching their heads on that point. The pandemic, which is touted to be worst than SARS back in 2003, is driving down global bond yields.
This is significant to bank stocks because their dividends look much more attractive as the gap between the yield from their shares and bonds widen.
The 10-year Australian government bond yield tumbled to 1.06% from 2.11% a year ago. Panic over the economic impact of the coronavirus pandemic is driving investors into safe haven assets like government bonds.
As the price of bonds rise, their yields fall because price and yield move in opposite directions.
Bank dividends worth more than others
Does this mean that dividend yields on other income stocks outside the big banks will also look more enticing during these trying times? Not quite. Big banks are backstopped by the government. Canberra will not allow any of the big banks to fail and the GFC showed this to be true.
The coronavirus isn’t the GFC and the government won’t prop up dividends or bank profits, but from a credit risk perspective, investing in bank stocks aren’t quite as risky as industrial stocks.
This means, cent for cent, bank dividends are worth more than from other stocks in my view.
Earnings outlook a second support
The earnings outlook for the big banks have also improved considerably. The Commonwealth Bank of Australia (ASX: CBA) share price jumped after its half year results came in ahead of consensus. The National Australia Bank Ltd. (ASX: NAB) share price also outperformed when it revealed its quarterly update.
The key takeaway from the results is the improving net interest margins (NIM). The market (and I for that matter) was expecting margins to shrink further due to record low interest rates. The increase in NIM may be very modest, but it looks stellar in my view when contrasted to the gloomy expectation.
Just as significantly, the unexpected jump in home loan commitments to a three-year high bodes well for the sector as a whole.
Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group (ASX: ANZ) haven’t provided an update, but when they do, and assuming their results confirms these bullish trends, the sector will run higher.
This is despite the fact that the big four have performed reasonably well as a whole versus the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index.
Investors have been willing to back these stocks for their dividends but have factored in no growth or a modest decline.
If the growth perception changes, these stocks will find a second wind.