A Contrarian’s Trade

Every once in a while you see a statistic that just defies logic.  The one that really jumped out at me (that I vividly recall) was during the financial crisis when I read on a Bloomberg Chart of the Day that the US banking sector had fallen as much as the Nasdaq had during the tech bust.  Although it made complete sense at the time, you just read a statistic like that and say “is this not overdone”?  The day that was posted just happened (by chance) to be the bottom of the market in 2009.

Given the fact that the Euro crisis is never ending (thanks to a lack of political compromise) it’s unlikely that the timing on this one will be anything remotely similar, but this statistic just jumped out at me as a sign of incredible skew in a large market.  It’s food for thought and as always, certainly not an investment recommendation, but a very nice 30,000 foot view of the collapse in European equities during the last few years.  The European financial sector is now smaller than Australia’s!  Now that has to make you go “hmmmm”.  (via Bank of America):

  • The US is by far the largest equity market ($12.8trn), Financials the largest global sector ($5.2trn) & US Tech the largest country-sector (at $2.5trn it now exceeds the entire Eurozone equity market capitalization).
  • The financial sectors market caps show that the BRIC banking sector is larger than Japan’s, and Australian banks are larger than Eurozone banks. (emphasis added).


Source: Bank of America Merrill Lynch


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • http://bubblesandbusts.blogspot.com Woj

    Fascinating. The tough question is obviously determining if Eurozone banks are undervalued, Australian banks are overvalued or both. My hunch is that a bit of both, but with Australian banks likely to take a bigger hit and sooner. Mortgage debt, which is extremely high, has been declining and taking housing prices with it. The remaining fallout from further declines seems widely unacknowledged to date.

  • LVG

    That is crazy. I wonder how much of this is due to the Aussie housing bubble and how much is due to Euro collapse. Probably a bit of both. Maybe you have an Aussie reader who can provide some more details on the banks there?

  • LVG

    CR – just curious if you bought the banks when you posted that link in 2009? That would have been a nice trade.

  • http://www.pragcap.com Cullen Roche

    I actually didn’t. I had bought a bunch of stuff the week before the mark to market decision and got incredibly lucky buying the Friday before the big Fed announcement on stimulus when the market bottomed at 666 or whatever it was. But banks weren’t part of those purchases. Like most people, I was pretty skittish at that point and I was trading in and out of the market. Early March 09 was the first time where I finally said “okay, this is getting overdone”….The key then (and now) was knowing when govt’s would step-in and move the goalposts. It’s funny how the macro drivers have changed a little bit, but the driver of the biggest equity rallies really hasn’t changed over the last 4 years. It’s still all about understanding when govt’s put the bazooka on the table.

  • Bill in Australia

    One big difference is that Australia has an undersupply of housing stock. In Australia, developers generally develop and sell the land to residential customers. The residential customer then engages a builder to design and build the house. So, Australia is much less likely to see the sort of thing that happened in the USA, Ireland, Spain, etc. where a housing bubble was fuelled by the construction industry.

    Also, banks in Australia are well regulated and well capitalised.

  • Apj

    Chart is interesting because, just eyeballing it, both banking sectors roughly quadrupled from 2203 before losing it all by 2009. The relative performance since then is hardly worth going into due to its obvious nature (low Aussie exposure to Europe etc etc, better capital positions,ore conservative regulation and so on). Suffice it to say that Aussie banks are now well overvalued IMO. They have the benefit of real sovereign support, but their exposure to housing is higher than ever. Cracks have been appearing in the Aussie economy for a few years now, and banks will surely get it in the neck as soon as the u-rate starts really going up. It is already trending higher, employment growth is barely above zero, the resources sector is suffering lower prices as China moderates, and the damn currency is still too high (which it was when it bettered 90c way back). It is clearly benefiting from flight to quality, as are our bank equities (like other countris like US) as money leaves the Euro. Seems its not enough to just push money from the periphery to the core now. Aussie and its banks quite risky at current valuations. Arrears and BDD aren’t too high yet, but they’re not falling. Careful. Timing is hard, but can Westpac share px continue going up at nearly a 20pc rate over 2mths indefinitely?

  • bb

    I feel like I’m taking crazy pills.

    Remove the European line from the chart, – now what part of the Aussie Banks chart screams “over valuation”. I looks like a moderately increasing line over the past ten years. This should not be too much of a surprise since;
    – Australia has not had arecession for 21 years
    – Aussie banks recapitalised heavily in 2009 (so market cap has increased more than shareholder value)
    – Australian banks have among the lowest default rates in the western world
    – Yes, recent employment growth is low, which is what happens when you have only 5.2% unemployment
    – Resource boom has only been a recent phenomenon in Australia – from 1991-2001 commodity prices were terrible, yet Australia experienced great GDP and employemnt growth. History has proven Australia is NOT dependant on China
    – Australia does not have a propery bubble – this is myth pushed by local vested interests and foreign hedge funds talking their “short banks” book
    – Unlike the USA, Australia has substantially higher wage rates (minimum wages +US$17 per hr), which all other tings being equal, allows households to service higher debt levels (hence the low default rates)- as an aside, this is why Aussie shares have been terrible!
    – Aussie banks lend to hold – unlike the US model, which lends to sell. This means the credit process is much more considered and conservative.
    – Australia property prices are at or below replacement cost as most local developers have lower profits today than four years ago (unlike the US in 2000-2005 where homebuilder profits trebled)
    – Aussie Residential rents have increased by 50% over the past 5 years in AUstralia pointing to chronic undersupply in key markets (like Sydney)
    – New Housing supply is at 30 year lows in some part of the country
    – Australia is a currency issuer and therefore we have government institutions which can support / stand behind every AUD liability in the Country
    – Despite our low mortgage default rates, mortgage rates are among the highest in the world (6%) – with plenty of scope for the central bank to lower rates if required (the RBA is the monopoly issuer of AUD)

    Just a couple of thoughts to get the debate going….

  • QQQ

    the contrarian take from this chart is to short the aussie dollar rather than going long EU.. simple logic: mean reversion and decoupling is bullocks..

  • http://macronomy.blogspot.com Martin

    Hi Cullen, I don’t think this statistic defies logic, given the level of leverage that has yet to be reduced in European banking still. I view banks as the second derivative of an economy, meaning it makes sense to buy financials when the economy is powering ahead but clearly it doesn’t make sense to hold financial stocks in a deleveraging environment. You would be much better holding senior unsecured financial bonds from good quality issuers or even covered bonds rather than equities, as far as the financial sector is concerned. There is still a lot of deleveraging to do in Europe in the financial sector. Banks will merge, delever and shed assets for many more years to come. Don’t expect any pick up in ROE anytime soon.

    In relation to the above graph, it would be much more interesting to plot the level of loan to deposit ratios between European banks and Australian banks to have a better view. Equity market caps doesn’t tell you much. We all know by now that the main issue with banks is our thin the equity buffer is to withstand acute crises.



  • Swede

    “The European financial sector is now smaller than Australia’s! ” Is that a joke? It’s impossible.

  • hangemhi

    Nice long “it’s different here” list.

    Curious what you think of Steve Keen? Is he “talking his book”?

    The Aussie property bubble has been bailed out by major incentives to home buyers. Will they keep doing that – with $50k incentives, $100k???

    Under-supply gets taken care of when everyone is out of work and bunks up. Many, many jobs are in construction and real estate related. When those jobs go, tons of other businesses get hurt. Then lots of other things on your list get taking out too

  • John Kaye

    BB – that “…moderately increasing line…” shows that Australian banks’ market capitalisation has nearly quadrupled in ten years. I disagree that this is a moderate increase.

  • bb

    I call BS on the chart – or at the very least it is extremely misleading. Market cap does not tell you much at all since all of the banks raised equity in 2009.

    Some share prices of the major banks will put this in context (dec 2003 versus today)
    NAB $29.95 now $24.81 (-2.1% CAGR)
    ANZ $17.68 now $23.75 (3.3% CAGR)
    CBA $29.45 now $55.52 (7.3% CAGR)
    WBC $15.99 now $23.62 (4.4% CAGR)

    Source: Blooomberg