Betting against the bank. ‘Widow-maker’ trades are making a comeback

In the hedge-fund world, betting against the big Australian banks is known as a “widow-maker” trade. This is finance slang for an investment move that looks sensible in theory, but has a long history of inflicting hefty losses on those who try it.

For years, the “bearish” case against investing in Australian bank shares has been built on the claim that our housing market is a debt-fuelled bubble, and that this leaves the banks that prop it up vulnerable. For years, betting against bank shares (especially the biggest, Commonwealth Bank) has generally not paid off.

Yet lately, banking bears have been growing in number, and you can see this in the number of people “short-selling” (a trading strategy where people bet on, and profit from, a falling share price).

Short positions in Commonwealth Bank have jumped from about 0.6 per cent of its shares last September to more than 2 per cent, according to the website Shortman, which draws on data from the Australian Securities and Investments Commission.

Short positions in Westpac, the second-largest mortgage lender, have risen a similar amount over this period to slightly less than 2 per cent.

That is hardly the only sign of more people taking a more gloomy view on banks. Much of the analyst commentary on banks has also been discernibly negative lately, understandably focusing on the risks from a slowing home loan market and the potential end of a multi-decade boom in property prices.

These risks are very real. For all this negativity towards banks, however, another thing is equally striking. Our banks are still making huge piles of money. CBA delivered a record $11 billion last year for example, with a very healthy return on equity of 14 per cent.

So how come CBA is churning out its biggest ever profit, yet more people are betting against it? Is it just the weak housing market, or are there other reasons why the market is down on banks?

To be fair, vocal debate about whether Aussie banks are overvalued is nothing new. Markets depend on people having different points of view about what something’s worth. It’s also common for a company to be churning out bumper profits (such as CBA) even as future profit growth looks more challenging.

Lately, however, the ever-present debate about whether Aussie banks are over-valued has come into sharper focus.

Like many issues in banking, a lot of it comes back to housing – the biggest source of Australian bank loans.

The great mortgage slowdown – which accelerated when Labor moved to rein in housing-investor tax breaks in the May budget – was a dominant feature of the results announced last week from Commonwealth Bank, Westpac and ANZ Bank. National Australia Bank will deliver an update on Monday, after it last month disclosed a 15 per cent slump in loan applications in the June quarter compared with the March quarter.

While it’s obvious home lending is slowing, however, no one knows by how much, or exactly what this will mean for banks.

Co-chief executive at fund manager Alphinity Andrew Martin says what we’ve seen from the banks over the past week doesn’t really resolve the debate.

“If you’re a bit more bullish, you probably say we’ve had a leg down, and it stabilises from here. If you’re bearish, you say it’s a rolling issue,” he says.

We can all agree that credit growth will slow, and banks’ revenue growth will be weaker, but we probably won’t know the extent of that weakness for months.

If it were only slower lending growth, then that would be a few percentage points of profit growth here or there. Mortgages are still only part (albeit a very large part) the banks’ profit engines, after all.

But as well as factoring in weaker growth, the market is also convinced the slowdown in home loans will have other significant knock-on effects for banks.

There’s already more competition to sign up customers, for example, which is pushing banks to cut their prices on loans.

If the housing market drop gets uglier, this could spill over into a weaker economy, which would in turn drive up banks’ bad debts.

These are the sorts of scenarios that are prompting more investors to turn bearish on the banks.

When you also throw in the energy crisis, which raises the risk of more businesses getting into strife and struggling to repay bank loans, this causes more analysts to cut their forecasts for bank profits, further fuelling the pessimism.

It’s certainly quite the change in sentiment towards four of the biggest companies on the ASX, which have long been favourite investments for self-funded retirees and super funds.

Yet for all the warnings of slowing growth, and the higher number of short-sellers targeting banks, it’s worth keeping all this in perspective.

For one, the dip in bank shares hasn’t been all that great – especially compared with the intense media focus on the weaker housing market.

CBA, for example, has underperformed the ASX 200 in the last six months, but it is still valued at $280 billion.

And just as the current weakness in housing should be compared with housing’s very strong long-term growth, CBA shares are still up more than 60 per cent in the last five years, compared with almost 20 per cent for the ASX200.

Short positions in CBA and Westpac have risen, but they’re still nowhere near the most-shorted stocks. Rio Tinto, for example, has 9 per cent short interest, while Domino’s Pizza has 12. 3 per cent.

Those attempting the widow-maker trade involving the banks may have grown in number, and their case is looking more convincing than it used to, but they’re still very much in the minority.

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