One of the stronger-performing sectors on the stock market this year has been ASX bank shares. Just look at how the biggest banks have performed in 2024 to date.
So far this year, the Commonwealth Bank of Australia (ASX: CBA) share price has lifted 37%, the Westpac Banking Corp (ASX: WBC) share price has jumped 41%, the National Australia Bank Ltd (ASX: NAB) share price has gone up 22% and the ANZ Group Holdings Ltd (ASX: ANZ) share price has climbed 11%.
Impressive stuff, considering the S&P/ASX 200 Index (ASX: XJO) has only gone up 8% this year.
Why have these banks risen so much? You'd need to ask each buyer of the banks at these higher prices to explain their investment.
I'll suggest a couple of possibilities for some of the gains, though.
First, there are plenty of institutional buyers who don't seem to mind the value they're buying at. I'm referring to superannuation funds and index (including ETF) funds—if they're given money to invest in Australian shares, then they need to allocate that money as per the investor's implied instructions.
The superannuation pool of assets and exchange-traded fund (ETF) balances continue to grow thanks to contributions and compounding.
Evidence is also mounting for a second tailwind for ASX bank shares.
Interest rate cuts on the horizon
One of the biggest concerns some investors had about banks was the possibility of rising bad debts if borrowers could not make payments due to the high interest rates.
While arrears are rising for ASX bank shares, the high house prices are helping reduce the danger of bad debts. The mortgage loan only goes 'bad' if the bank can't recover the full loan amount after the sale of a property.
Potential rate cuts by the RBA could help this dynamic further, with the Australian central bank seeing some progress on inflation. In the December monthly statement, the RBA said:
While headline inflation has declined substantially and will remain lower for a time, underlying inflation is more indicative of inflation momentum, and it remains too high. The November SMP forecasts suggest that it will be some time yet before inflation is sustainably in the target range and approaching the midpoint. Recent data on inflation and economic conditions are still consistent with these forecasts, and the Board is gaining some confidence that inflation is moving sustainably towards target.
To me, that suggests that an interest rate cut is on the cards in 2025, though not necessarily right at the start of the year. While a rate cut may not help the banks' net interest margin (NIM), it should reduce the risk of bad debts if borrowers can more easily afford their repayments.
However, home prices in Sydney and Melbourne are currently declining, which is a headwind. Time will tell how long these declines last.
Is this the right time to invest in ASX bank shares?
While the outlook for banks is somewhat promising, it seems like the market has already taken a very optimistic view of them, hence the large gains this year. In recent notes, the broker UBS has pointed out that banks are trading at a significantly higher level than they have historically been.
I'm going to use the UBS estimates for earnings per share (EPS) and the broker's calculation of the price-to-book ratio for some of the banks. In other words, how are the bank's shares valued compared to its earnings and balance sheet value?
The NAB share price is trading at 16x FY25's estimated earnings and a price-to-book ratio of 1.8x
Westpac's share price is valued at 17x FY25's estimated earnings with a price-to-book ratio ratio of 1.5x.
The CBA share price is trading at 26x FY26's estimated earnings and a price-to-book ratio of 3.4x.
The banks' rally this year has largely come from their share prices becoming more expensive, as shown using the investor metrics above rather than earnings growth.
Compare those P/E ratios to arguably one of the world's best banks. According to Google Finance, the JPMorgan Chase (NYSE: JPM) share price trades with a P/E ratio of just 13.4. JPMorgan Chase's earnings multiple is half that of CBA.
I don't think this is the right time to invest in ASX bank shares. Given their high valuation, future returns could be relatively low, so I'm looking for opportunities elsewhere.
