Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 108

Don’t treat bank shares as defensive assets

Residential property constitutes by far the largest asset class in Australia, and on average, property accounts for over two-thirds of Australian households’ net worth. If you include investment in the bank shares, which are themselves heavily exposed to property, the average Australian household has about 70% of its net worth ‘at risk’ exposure to residential property.

What does this mean for the share market?

Various commentators have recently warned that the market valuations of the four major domestic banks are high. But instead of analysing P/E multiples, low credit losses or high payout ratios, in this article we apply a ‘big picture’ outside view of the banks.

Australian banks have been outstanding performers from both a revenue and share price perspective. Currently all four major Australian banks (ANZ, Commonwealth, National Australia Bank, Westpac) are among the largest 14 banks in the world by market capitalisation, which is extraordinary given that no German, French, Italian, or domestic British bank is in that top 14. There is one Japanese bank in the top 14, whereas 25 years ago, when the Japanese property bubble was at its peak, nine out of the top ten banks were Japanese. This is not just a question of market concentration — the entire Japanese banking sector value is 20% less than the big four Australian banks together.

Another useful comparison across countries and history is the size of the banking sector relative to the value of all the other listed companies in (Figure 1).

Figure 1:PH Figure1 050815

PH Figure1 050815

The Japanese banking sector accounted for just above 20% of the market at the 1990 peak of the Japanese debt and property bubble. A similar level of 20% was reached by the UK banking sector at the peak of the pre-global financial crisis boom in the 2000s (though this was enhanced by non-domestic banks, such as HSBC and Standard Chartered, being listed in London). The index weight of Australian domestic banks is over 30%, a level not even reached during lending and property bubbles in markets overseas. It seems reasonable that the value of a nation’s (listed) bank sector should bear some relationship to the value of its (listed) national economy. Across the world this ratio is about 1:10; in Australia it is 1:2.

Australian banks do well because there is a lot of debt

Why are Australian banks so highly valued? Put simply, Australian banks earn very high profits. However, this is not because, in our view, they are better run, enjoy better margins, or use more advanced technology, but because there is a lot of debt in Australia. This debt is effectively the top line of a bank’s P&L — the more debt, the more net interest and fee income.

Figure 2:PH Figure2 050815

This relationship is illustrated by Figure 2, which shows financial sector profits (which are dominated by banks) relative to GDP and outstanding credit to GDP. As both quantities are expressed as a percentage of GDP, one might expect a steady ratio. Instead we find that since the late 1950s credit has grown about five fold relative to GDP and so have financial sector profits. In this sense the high valuations of Australian banks have been driven by the same drivers as in the United Kingdom before the global financial crisis, and in Japan before the bust.

Figure 3:PH Figure3 050815

The household sector has primarily been responsible for this growth in debt, as individuals have increased borrowing to purchase residential property. Figure 3 shows the household debt to income ratio over time for the United States and Australia. We note three features of these developments. Australian household gearing, previously much more conservative than that in the United States, rose very rapidly between 1990 and 2008 and exceeded US debt levels. US households have de-geared since 2008 while Australian households have not, and indeed the latest data show new record highs in Australia. The gap to the United States has thus widened further.

This data is not encouraging, but we note that there have been some positive lessons learned from the US crisis. ‘Low-doc’ lending, which the banks were just ramping up in the lead-up to 2008, seems to have mostly disappeared, liquidity levels at the banks have improved dramatically, and regulators have insisted on them holding significantly more capital. This does help but to what extent, if the lending and speculative investing continue unchecked? One is inevitably reminded of George Santayana’s well-known aphorism that ‘those who do not learn from history are condemned to repeat it.’

What to do?

These risks are real, in our view, but we do not know when and how these distortions will be remedied. We are more confident that, in a decade hence, this distortion will be obvious, like so many others before it. In the meantime, however, we face difficult choices. Given the uncertainties, and in particular our lack of information about the timing of any adjustment, how can investors sensibly and prudently proceed?

We describe two actions that can be taken within the context of the Australian stock market:

  • Investors around the world have sought out stocks with sound yields and defensive earnings, focusing on the utility, infrastructure, health care, and telecommunications sectors. However, in Australia (and only in Australia, it seems), this focus has included banks. Given their gearing and exposure to the domestic economy, we do not subscribe to this local view of banks as defensives.

    In our view, however, there are genuine defensives within the Australian market, in the sense that a sharp economic downturn would affect such companies less. These companies may have their own idiosyncratic problems at times, but they can mitigate macro-economic sensitivity within a portfolio. In our view, not all yields are created equal and some are safer than others.

  • There are, furthermore, successful Australian companies that have expanded globally and now run competitive businesses offshore or export to other nations. These companies can act as hedges to the Australian residential/bank exposure because a decline in the Australian dollar, lower wage growth, and spare capacity in Australia would raise the value of these companies. We believe the value of these companies would be enhanced in local currency in the event of a recession finally ending Australia’s remarkable run of 24 years without a downturn and its associated 24-year run of increasing household leverage.

In closing, we would like to stress that we are not predicting an imminent crash in Australian property prices. However, investors should be aware of the enormous exposure Australians have to this risk and that property and banks are likely to be highly correlated in any downturn. And while we can’t predict when these market distortions will start to unwind, we suggest that investors consider treating banks less like defensive holdings and consider domestic companies with global exposure in their portfolios.


Dr Philipp Hofflin is a Portfolio Manager at Lazard Asset Management. This article is general information and does not address the personal needs of any individual. This article is an extract from the longer version and is reproduced with permission.



Leave a Comment:



10 reasons not to hold bank royal commission

Is bank bias worth the risk?

Are Australian bank boards fit for purpose?


Most viewed in recent weeks

How to enjoy your retirement

Amid thousands of comments, tips include developing interests to keep occupied, planning in advance to have enough money, staying connected with friends and communities ... should you defer retirement or just do it?

Results from our retirement experiences survey

Retirement is a good experience if you plan for it and manage your time, but freedom from money worries is key. Many retirees enjoy managing their money but SMSFs are not for everyone. Each retirement is different.

A tonic for turbulent times: my nine tips for investing

Investing is often portrayed as unapproachably complex. Can it be distilled into nine tips? An economist with 35 years of experience through numerous market cycles and events has given it a shot.

Rival standard for savings and incomes in retirement

A new standard argues the majority of Australians will never achieve the ASFA 'comfortable' level of retirement savings and it amounts to 'fearmongering' by vested interests. If comfortable is aspirational, so be it.

Dalio v Marks is common sense v uncommon sense

Billionaire fund manager standoff: Ray Dalio thinks investing is common sense and markets are simple, while Howard Marks says complex and convoluted 'second-level' thinking is needed for superior returns.

Fear is good if you are not part of the herd

If you feel fear when the market loses its head, you become part of the herd. Develop habits to embrace the fear. Identify the cause, decide if you need to take action and own the result without looking back. 

Latest Updates


The paradox of investment cycles

Now we're captivated by inflation and higher rates but only a year ago, investors were certain of the supremacy of US companies, the benign nature of inflation and the remoteness of tighter monetary policy.


Reporting Season will show cost control and pricing power

Companies have been slow to update guidance and we have yet to see the impact of inflation expectations in earnings and outlooks. Companies need to insulate costs from inflation while enjoying an uptick in revenue.


The early signals for August company earnings

Weaker share prices may have already discounted some bad news, but cost inflation is creating wide divergences inside and across sectors. Early results show some companies are strong enough to resist sector falls.


The compelling 20-year flight of SYD into private hands

In 2002, the share price of the company that became Sydney Airport (SYD) hit 80 cents from the $2 IPO price. After 20 years of astute investment driving revenue increases, it sold to private hands for $8.75 in 2022.

Investment strategies

Ethical investing responding to some short-term challenges

There are significant differences in the sector weightings of an ethical fund versus an index, and while this has caused some short-term headwinds recently, the tailwinds are expected to blow over the long term.

Investment strategies

If you are new to investing, avoid these 10 common mistakes

Many new investors make common mistakes while learning about markets. Losses are inevitable. Newbies should read more and develop a long-term focus while avoiding big mistakes and not aiming to be brilliant.

Investment strategies

RMBS today: rising rate-linked income with capital preservation

Lenders use Residential Mortgage-Backed Securities to finance mortgages and RMBS are available to retail investors through fund structures. They come with many layers of protection beyond movements in house prices. 



© 2022 Morningstar, Inc. All rights reserved.

The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.