Good afternoon, 
First off, sorry to all of you for sending you the Seneca Essentials email by accident one day last week. Just selected the wrong distribution list on MailChimp. I clearly hadn’t had my 1st coffee for the day! If you want to get our overnight prices summary, trading wrap and other news that catches my eye, feel free to reply to this email and I’ll add you to the distribution list.

ASX 200 was down 1.57% for the week led lower by the miners and defensives (interesting mix to be honest). Only healthcare and information technology stocks were spared. 


The Big 4 Banks

Last week we saw results from ANZ and NAB, which aside from being important for shareholders, can provide us with some higher level insights about the economy and the households and businesses that make it up. Westpac (WBC) reported this morning.

My general comment about the ANZ result would be ‘pretty good considering’ and the NAB would be ‘its cheap because it’s a basket case. It might get better, so maybe its good value.” I’ll spend a bit more time on the Westpac report this arvo but on face value, it looks a bit low, although there’s nothing to be too worried about.

All in all, I’m not super bearish on banks and for those shareholders who are just happy to hold for the dividends, those dividends will remain fairly stable. A 15% cut to the dividend at NAB isn’t great, but it’s already in the price so who cares. If you are surprised by the scale of this dividend cut, you clearly haven’t been reading this note each week.

I could talk about the specifics but bugger it, you don’t actually care. You just want to know if banks are a good investment – The answer is NO.

There’s further downside risk from continued and protracted declines in home loan volumes and despite dividend yields being well covered, capital adequacy pretty solid and a 30% discount to relative valuations, it’s hard to find much to get excited about. Maybe if you’re trying to make a case to own them it’s on the back of an expectation that stabilising funding costs, a bit of a cost-out tailwind and sustained low bad debt expense suggests that at current prices, they are underappreciated?

I sound like a broken record but the banks are a leveraged play on the economy and as I’m about to explain, the economy doesn’t look too crash hot.

Banks are trading on c.9% gross dividends, 12x earnings and at a 30% discount to their normal discount to market PE or a 25% discount to normal Price to Book.

 


Property Prices & The Australian Economy

Things are not looking good for property prices. We’ve already had capital city dwelling prices fall 8.81% y.o.y. (to 30 April) and every major market was down month-on-month except Canberra.
(Source: CoreLogic)

And in amongst the ANZ bank result, I saw this chart which shows the percentage of home loans that have actually missed a payment on their mortgage. Aside from the lunacy that is Western Australia (for all my Sandgroper friends and family, it’s going to get worse, not better), I fear that Victoria and NSW might be next to join the party.

 

Why?

Well, it’s really a couple of things, one is that there is still an elevated quantity of loans switching from “interest only” to “principal and interest” for the next 2 years. This is just ANZ numbers but NAB looked pretty much the same with $7-8bn per half for the next 4 halves.

Why is this a problem?

Well there’s a fair bit of negative equity in WA, QLD & NT to start with…

And it seems to me that about 5-6x disposable income seems to be a pretty decent median house price.

It’s not just “valuation” that I think is the issue. It’s access to credit. I don’t believe that APRA are going to be saying to the banks:

“Oh, remember how you used to let people falsify their income and expenses so that you could lend them heaps more than they could actually afford on the assumption that property prices were rising faster than consumption?… well, you’ll be happy to hear that we think that this sort of reckless behaviour is ok now that prices have fallen, we are going to let you do that again.”

Never. going. to. happen.

So if you’re wages aren’t going up and your ability to borrow is less today than it was 2 years ago, then can you pay more or less for a house?

LESS (that means less demand for the economically challenged).

And if you own a house as an investment and you are losing on the cash flow in the hope the value of the property goes up – and it doesn’t – what are you going to do?

SELL (and that’s more supply).

More supply. Less demand…. I only got a B in grade 9 ‘intro to economics’ but even I can tell you that that means prices fall.

How bad does it get?

Here’s a history lesson…

It looks like it’s got another >5% to go given the pace.

This is not good news for banks. It means we don’t want to buy their product (loans). Additionally, as interest rates are already low, if the RBA cuts, it won’t drive up loan growth/prices because the banks are working out (when they calculate how much money they will lend a homebuyer) if you can repay at 5% and 6% interest rates and not care about 25 or 50bps over a 25-30 year loan.

It’s all about RESPONSIBLE LENDING now – not about volume growth…

Further, this doesn’t help existing homeowners much as it’s the principal component of their repayment that’s making their life difficult. The lack of equity they thought they would have accumulated by now is the icing on the cake.

This means we don’t spend as much money, we don’t take on risk, and the economy just grinds along at low rates of growth, propped up by east coast government infrastructure spending and the odd new mining construction project.

Even the best retailers are battling and it’s not because they don’t run a tight ship… its because it’s bloody tough out there. Nick Scali’s (NCK) just got downgraded by Citi to a SELL on the back of these housing-related headwinds. Go look at Beacon Lighting (BLX) for reference:

Prediction:  RBA cuts AT LEAST once this year. If Labor is elected, the first one will be straight after.


Movers & Shakers

Pilbra and all the lithium miners were up on the back of Wesfarmers (WES, 0.07%) takeover of Kidman (KDR, +41%). Zip (Z1P, +16%) and Afterpay (APT, +8%) also had strong weeks.

Fund managers Janus Henderson (JHG) and Pendal (PDL, the old BT) struggled with outflows whilst Macquarie (MQG) guided to slowing growth (but my experience tells me they often under-promise and over-deliver).

Have a good week,
LL