Why Analysts Believe the Banking Sector Is Overinflating the ASX

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Financial consultancy Lazard is predicting tough times ahead for banking stocks…even as the sector’s share of the ASX200 has risen to record levels. In fact, it’s this extraordinary share of the index that’s raising such concerns. Let me explain…

Lazard believes the ASX stock market index is completely overvalued, and that the banking sector is responsible for this. I know what you’re thinking. Didn’t the banking sector just shed $60 billion off its value on the ASX in March? That’s true. But it doesn’t disprove the fact that the banking share of the index is over proportional.

The banking sector accounted for 42% of the ASX200 index in March before the selloff. That’s in contrast to materials and energy, which fell to 16% of the share of the index.

In an ideal world, the share of the index would be split evenly among different sectors. That would imply that there is value across the broader range of sectors on the share market. But that’s not what we’re seeing.

The ASX’s current trending is becoming more concentrated. What else could explain the banking sector making up almost half of the totalASX200? As Lazard says, far too many investors are seeking ‘safety in numbers’. And this overconfidence in the banking sector could lead to a drastic market correction in the index once investor sentiment shifts away from banks.

For a detailed view as to the uncertainty surrounding banking sector stocks, I urge you to read The Daily Reckoning’s Terence Duffy’s take on it here.

Are banking stocks in 2015 what tech stocks were in 2000?

Investor confidence driving up one outstanding sector is nothing new. We’ve seen it play out several times over. You only need to look at the trends the ASX200 exhibited in the past 15 years.

The first trend reached a breaking point in 2000. That was when tech and telco stocks made up a whopping 37% of the ASX index. It didn’t end well. Investors lost millions buying into stocks that weren’t generating any cash.

The second of these crashes occurred in 2008. By this point tech stocks had declined to less than 10% of the index. But mining was there to pick up the slack. The mining boom was in full swing in 2008, and materials made up 39% of the index. Cut to seven years later, and materials and energy make up 16% of the ASX index today.

That’s why Lazard believes the banking sector is the latest that will undergo a market correction.

To put all this into context, you only need to look at what a healthier stock market index looks like. The biggest company on the US S&P500 makes up no more than 3% of the index. As Lazard points out, that gives the S&P500 depth, and it provides a good measure of performance.

What’s causing the banking sector’s high stock market valuation?

The problem is that the price of bank shares is at an all-time high — relative to profits. That implies that shares are trading at far in excess of their real value.

Lazard analysts believe the banking sector’s overvaluation is a result of growth in lending. In other words, the expansion of credit resulting from lower interest rates has fuelled their profits and stocks. Lazard question whether this practice is sustainable in the long run.  Lower than expected earnings, such as the AU$2.5 billion in profits announced recently by Commonwealth Bank [ASX:CBA], support their concern. It suggests that medium term growth prospects at CBA are close to reaching their ceiling. That explains the $60 billion selloff across banking stocks in March. But as long its share of the ASX200 index remains as high as it is, banking stocks will remain overvalued.

None of that’s to say that Lazard thinks banks will implode anytime soon. But they do think investors would be wise to keep their distance from banking stocks.

Mat Spasic,

Contributor, The Daily Reckoning


PS: The banking sector isn’t the only one under threat of a market correction in the near future. In fact, falling share prices in the market points to a much larger collapse soon.

The Daily Reckoning’s Vern Gowdie believes we’re going to see a catastrophic crash in stocks. Vern is the award-winning Founder of the Gowdie Family Wealth advisory service. He’s been ranked as one of the Australia’s Top 50 financial planners. And he thinks the ASX could lose as much as 90% of its $1.8 trillion value.

That’s why Vern’s written ‘Five Fatal Stocks You Must Sell Now’. In this free report, Vern wants to help you avoid the coming wealth destruction. He’ll show you which five blue chip Aussie companies could destroy your wealth. And you almost certainly own one of them. To find out how to download the report, click here.

The Daily Reckoning
The Daily Reckoning offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, The Daily Reckoning delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors. Founded in 1999, The Daily Reckoning is published in 7 countries with a worldwide readership of almost 1 million people.

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