All Ords Report 13 December 2017

Will this newly announced Royal Commission into misconduct in the financial services industry impact the value of your bank shares?

We’ve been given many reasons as to why Australia shouldn’t hold a Royal Commission, including that our bank shares, held by most Australians by way of our superfunds, will fall. And let’s not forget the incredible cost and waste of taxpayer funds that come with a Commission.

Evidence indicates that some banks haven’t followed the rules and so they need to be held accountable, but is a Commission what we need? Perhaps you believe, after hearing how banks continue to be caught out and yet they still keep making so-called ‘bloated’ profits, that this Royal Commission is needed to sort them out?

Firstly, let’s keep bank profits in context. While their profits may appear large in dollar terms, actual earnings per share are typically single digit returns, and in some years earnings are low single digits.

Also, a Royal Commission doesn’t guarantee bank practices will change. Besides, if we need a Royal Commission to make banks operate more honestly there’s something very wrong with the current system of self-regulation. So how do we fix that?

Big banks have paid fines for misconduct in the past and at the time of the announcement the shares typically fall temporarily, only to rise some time later. Let’s look at an example….

On 3 August 2017 it was announced that Australia's financial intelligence and regulatory agency, AUSTRAC, had initiated civil penalty proceedings in the Federal Court against the Commonwealth Bank of Australia (CBA) for serious and systemic non-compliance with the Anti-Money Laundering and Counter-Terrorism Financing Act 2006.

What happened to the share price?

From the close on 3 August 2017 CBA fell by 12.8 per cent. Since then the stock has recovered and is trading at around 50 per cent of the distance it fell.

As the turmoil around the banking sector has intensified in recent years I believe that much of the negative sentiment has already been priced into bank shares. So while prices may remain soft in the short term, probability indicates that a recovery is likely to follow.

The Federal Government has said that the royal commission will end after 12 months, with a final report due by February 1, 2019.

What do we expect in the market?

The Australian market has been somewhat lacklustre over the past couple of weeks, however, this week the All Ordinaries Index (XAO) has edged higher to test the recent peak at 6,124 points in November.

Interestingly, last week the market moved down to create what appears to be a soft landing, hovering just above 6,000 points. Given this, there remains the opportunity for our market to trade into the 6,200 to 6,400 target zone in December.

The announcement about the Royal Commission into the financial services industry hasn’t shaken the broader market. Witnessing the banks come together to announce the need for an investigation may have halted a revolt, lowering the uncertainty around this sector. Remember, we need bank shares to rise for the overall market to continue higher, so the sooner both sides appear to be working toward a solution, the sooner we are likely to see the current cycle unfold.

Another point to remember about bank shares is that they run in cycles and the shorter term cycles can be used to generate an income. In referring to income generation, this is not about having to wait for dividends to hit your bank account a couple of times a year. This is about being able to generate a regular income from rising or falling prices. I can teach you how to do it, so would you like to learn?

Global news

Abroad, excitement over US tax reform has continued to support higher share prices there, however, once the market receives confirmation of the details of the reform it will have been fully priced into US shares, which means we are likely to see this market take a breather shortly thereafter.

With President Donald Trump's tax plan passing the senate, investors have been trying to assess how a tax overhaul will impact company earnings. Reportedly, banks, retailers and select stocks appear to benefit most from the tax cuts.

To Asia, there’s continued talk that the Chinese Government plans to rein in debt, abandon long-term economic targets and allow Gross Domestic Product (GDP) growth to fall. China’s GDP growth target is around 6.5 per cent, still high relative to Australian GDP.

While commentary still purports doom and gloom about rising debt and falling growth in China, it would be fair to say that the decline from double digit growth appears to have created a soft landing for Australia.

Year on year, Chinese retail sales climbed 10.0 per cent in October, marginally lower than forecast.

The Shanghai Composite Index (SSEC) has softened recently, which is to be expected following a steady rise since February 2016. It is possible we will see a further slight decline before the next rise commences.

As this is my final market report for 2017, I would like to wish you all a safe and Merry Christmas and a Happy New Year. I look forward to updating you on the market in the New Year.

Dale Gillham is Chief Analyst at Wealth Within