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Top bank shares

This article appeared in the January 2011 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

Learn how to move between bank shares to boost returns and outperform the market.

Photo of Alan Hull By Alan Hull

The four big banks have virtually been a proxy for the broader sharemarket for almost the past two decades because of their popularity. That is, if we take the view that the broader market is going to rally, we can probably use the big banks to exploit that. First I'll qualify my opinion about the broader market being set to rally.

I believe the best way to understand what the market is up to today is to go back to when John Connolly became Secretary of the US Treasury in 1971. He implemented a stimulus program that included quantitative easing (similar to what we are seeing today in the US) and the medium-term response from the sharemarket was a rally over the ensuing 12 months (see circled area in the chart below).

SP-500 Cash monthly

SP-500 Cash monthly image

Source: SuperCharts by Omega Research

Given the similarities between the early 1970s and now (in terms of fundamentals and technicals), there is no reason why we should not see markets enjoy a rally on the back of the current quantitative easing by the US Federal Reserve. But I qualify that statement by saying I think global fundamentals remain very fragile, although a good dose of liquidity can overcome many ills, at least in the short term. 

Charting proves the opportunity

So how can we make the most it with the help of the four big banks? Because the banks have been a favourite of investors and traders alike for nearly two decades, they ought to provide some leverage over the broader market - the broader market being defined in this article as the S&P/ASX 200 index.

If I am right, we should be able to overlay the banking sector index with the ASX200 and see the sector index advancing more quickly, in both upward and downward directions. That is exactly what the following chart demonstrates. The ASX200 is the red line and the banking sector index is the blue line.

ASX 200 weekly chart overlaid with the banking sector index

ASX 200 weekly chart overlaid with the banking sector index

Source: SuperCharts by Omega Research

This confirms that in recent times the banking sector has been providing a small but not entirely insignificant amount of leverage over the broader market. I dare say the resources sector would yield a similar result.

I have adjusted the banking sector index by using a multiplier of 0.83 so that it sits directly over the top of the ASX200 index for the period shown in the chart. This alters its magnitude, but in no way does it distort its overall shape, therefore does not interfere with my conclusion about the leverage the sector will provide over the ASX200 index.

Owning the four big banks would effectively replicate owning the banking sector index but their combined influence will only provide a fairly small amount of leverage over the broader market. Therefore, I think we need to dig deeper and see if there is some other tactic we can employ to gain further advantage - look at the banks themselves to see if they are all the same.

Weekly chart with CBA, NAB, ANZ and WBC overlaid

Weekly chart with CBA, NAB, ANZ and WBC overlaid

Source: SuperCharts by Omega Research

I would say they are similar but not the same. Note in the chart above how CBA has rebounded much further in recent times than the others. So the characteristic we can exploit here is the big banks' tendency to revert to the mean.

In other words, they typically run together and if one gets ahead of the others (in terms of its share price) we can reasonably assume that at some point it will fall back. Inversely, we can also assume that if one of the banks gets behind the others, it will inevitably catch up. There may be a case here for switching banks.

A simple tactic would be to monitor which bank is ahead and which bank is behind the others (in terms of share price) and then constantly shift our money from the leader to the lagger. Because the four big banks are primarily held by investors rather than traders, I would actually be far more inclined to execute this strategy using fundamental analysis rather than technical analysis.

To keep this discussion reasonably simple I will only use two key fundamental parameters: the current and 2011 forecast dividend yield, and the current and 2011 forecast price-earnings ratio (P/E). Using the StockDoctor program, I get the following numbers for the four big banks (at the time of writing);

Current yield Forecast yield Current P/E Forecast P/E
Commonwealth  5.69% 6.09% 12.90 12.28
NAB  6.22% 6.67% 11.76 10.39
Westpac 6.00% 6.31% 11.86 11.52
ANZ 5.30% 5.98% 12.19 10.90

On the basis that a bank is ahead of itself (in terms of share price), if its dividend yield is lower than the others and its P/E ratio is higher, then CBA is ahead of the others while NAB is the biggest laggard. On this basis I would have more capital invested in NAB than CBA until circumstances change.

I would also recommend that this simple re-weighting strategy could be executed on a quarterly or even half-yearly basis.

About the author

Alan Hull is a second-generation share trader, fund manager, businessman, writer, mathematician and IT expert. He is author of the best-selling Blue Chip Investing and Active Investing - A Complete Answer, both from Wrightbooks.

From ASX

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