2024 has been a wonderful year to be the owner of S&P/ASX 200 Index (ASX: XJO) bank shares. Shareholders will be hoping that 2025 is another good 12 months for those businesses.
In 2024 to date, Commonwealth Bank of Australia (ASX: CBA) shares are up almost 40%, Westpac Banking Corp (ASX: WBC) shares are up 45%, National Australia Bank Ltd (ASX: NAB) shares are up 28%, and ANZ Group Holdings Ltd (ASX: ANZ) shares are up 22%.
The economic environment could shift significantly from here for banks, with both positives and negatives getting stronger.
Australia's housing market is weakening, particularly in Sydney and Melbourne. However, every month that goes by brings an interest rate cut closer in Australia. Will the bulls or bears be proven right?
The investment team from Schroders have given some views on the banking sector.
High valuations
Schroders points out in its 2025 outlook that CBA's market capitalisation is rising towards 10% of the ASX share market's total value and about the same percentage of Australian GDP. The analyst team suggests that CBA shares are trading at more than three times their book (balance sheet) value and have a price-earnings (P/E) ratio of 25.
It was noted that historic bank valuation measures are "not proving useful predictors of the CBA share price direction."
Schroders believes the way the economy has evolved is not particularly helpful:
…decades of overusing money and interest rates in an attempt to steer the economy have left an economy well supplied with the beneficiaries of a financial economy (accountants, lawyers, bankers and insurance brokers) and less well supplied with those necessary for the real economy (engineers, teachers and healthcare and construction workers). Asset prices and debt levels have continued to disconnect with underlying profits and wages, leaving asset owners happy and younger wage earners holding the can. Increases in money supply which continue to outpace productive investment opportunities have spurred already high asset prices and speculative appetites.
Schroders asserts that ASX 200 bank shares have seen a significant rise in their P/E ratios.
House prices could be key
Schroders also warned about the impact of how much the ASX share market is reliant on the housing market:
As banks have soared higher and bad debts have remained near zero, the drivers of the housing market will remain crucial drivers of equity markets. As fundamental support fades, confidence and expectations around the trajectory of house prices have far reaching ramifications.
As we digest the implications of another Chinese stimulus package, where a significant proportion is directed towards recapitalising banks suffering from the continuing downdraft in real estate prices and the associated weakness in housing and consumer demand, the lessons for Australia are obvious. The long-run cost of unduly relying on housing as an economic engine and policies which divorce prices from fundamentals is high.
My view on ASX 200 bank shares
With the share prices of the major banks, Macquarie Bank Ltd (ASX: MQG), Bendigo and Adelaide Bank Ltd (ASX: BEN), and Bank of Queensland Ltd (ASX: BOQ), all going up more than 20% in the past year, I'm not expecting 2025 to be strong again.
Earnings growth has not caused the valuation increase; it has been investors' willingness to pay a higher earnings multiple. I don't think it's sustainable for P/E ratios to keep going up and up unless they're accompanied by rising profit, which seems challenging at the moment, with strong competition hurting lending margins. Falling house prices raise the risk of bad debts for the banks, in my view.
I don't think the ASX 200 bank share sector will be one of the strongest in 2025, particularly with the historically high valuations banks are starting at.
