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#Bear Case
Last edited 2 months ago

05-July-2020:  I've copied this from a forum post reply here (of mine), because I think it's a decent Bear case. 

First off, I would echo Strawman's concerns about the banking sector in general and about NAB in particular. People talk about how the banks will always be good investments over long periods of time, and that is of course based on past history. They had everything going for them for a very long time, and that environment has now changed considerably. Very low interest rates for a number of years are going to hurt them. Their net interest margin (NIM) is going to be lower, which directly affects their profitability - adversely. They are going to have to increase their bad and doubtful debt provisions due to the current recession and associated higher unemployment.

In short, if you're in your twenties and want to buy some banks now and leave them in your super fund for 40 years, you could do well, but my view is they're going to get cheaper, so if you want to hold them, you could wait and buy them at lower levels. However, if you're more of a hands-on, active self-directed investor, you can do a LOT better than the banks.

In FY2020 (the financial year just ended), the worst 3 sectors were Energy (down 29.2%), then Banks (down 27%), then Insurance (down 23.9%).

The best performing sectors were Consumer durables & apparel (up +45.9%) followed by Pharmaceutical & Biotech (+32.3%), Software & services (+19.9%) and Retailing (up +15.2%).

Of the size categories, the MidCap50 has outperformed (down 2.1%) from the Small Ordinaries (down 5.4%), the ASX100 (down 10.6%) while the ASX50 (which includes the banks) was down 12%. Mids and Smalls have outperformed Large Caps. That's interesting, because smaller companies usually get sold down the most when there is a crash or correction, and I believe that was the case in March, however, they tend to soar higher and faster during a recovery, as we saw in April and May.

In general terms, unless a large company has been irrationally sold down to unsustainable levels - which certainly can happen - they tend not to double or triple - in share price terms - over one or two years, like smaller companies can. Of course the share price of smaller companies also have plenty of downside risk;  they can halve or drop 90% a lot quicker and more often than you are likely to see in the large-cap space. But in general terms you are likely to get more bang for your bucks from smaller companies, and you can reduce the downside risk by doing plenty of research (sometimes called due diligence or DD) and choosing the companies you invest in wisely.

In terms of NAB specifically, they have been perennial underperformers for decades. One of the arguments I keep hearing is that there is more upside in NAB because they have underperformed the other banks for so long that they MUST be due to outperform. That's the "every dog has his day" argument. Investing is sometimes a little like betting on horse racing. There is certainly an element of luck involved. However, if you spend a lot of time studying the form guides and researching the horses, the jockeys, the owners, and the industry, you can certainly gain an edge on other participants. Would you say, "that horse has run last or second last in every race for 10 years, so I'm going to back it - because it's GOT to be due to win soon"? I hope not! Even if the horse got a new jockey and a new owner, and a shiny new stable, it's probably still going to be a loser. And that's how I feel about NAB.

CBA, WBC and ANZ are all trading at higher levels than where they were 20 years ago.  NAB are trading around -20% below where they were 20 years ago.  They are also paying less in dividends now than they were 20 years ago, which looks even WORSE if you allow for inflation.  They have certainly been the "dog" of the Australian banking industry, and there is little reason to expect that their dismal performance is suddenly going to reverse.  This ugly caterpillar is unlikely to transform itself into a stunning butterfly!  Perhaps a Bogong Moth...

Even if we had reasons to think they could turn this all around, as many fine investors have pointed out over the decades, turnarounds rarely turn successfully, and those few that do usually take a lot longer to do so than most people expect.  And the bigger the company is, the harder it is, and the longer it takes, to turn it around.  Turnaround plays are not a favourite of mine.  They rarely work out well.

Another "positive" I hear about NAB is that they have more exposure to business banking than CBA, ANZ or WBC (who are all more exposed to residential housing and less exposed to business). Some pundits claim that at various points in the cycle, greater exposure to businesses and a lower exposure to residential housing is going to benefit NAB. Again, if it hasn't in the past 20 or 30 years, why would it now?

I personally believe there are likely to be a lot more defaults on business loans, personal loans, and housing loans, which will affect ALL of the big 4 banks. And will affect MQG (Macquarie Bank) a LOT less, which is why they are my preferred exposure in the sector - they are really a firm of global asset managers now, not a domestic bank at all. However, even Maquarie look too expensive to me at current levels, so I don't own any MQG shares either. I certainly don't hold any NAB, CBA, WBC or ANZ shares!

Whether one bank will be adversely affected MORE or LESS than the other 3 is a mute point. You don't HAVE to own banks at all. There are so many better places to invest where the industry and the individual companies within it have strong tailwinds instead of headwinds.

Another argument for the banks is that they pay above-average dividend yields and will continue to do so, so they are pretty hard to beat for income-seeking investors. I believe that the bank's dividends will continue to reduce because of the headwinds they face. Their share prices might reduce even more, so their yields might continue to look acceptable even as they are reducing (because of their reducing share prices). However, if you suffer a capital loss (due to share price decline) that is significantly greater than the income (dividends) produced by that investment, it will NOT have been a good investment. And there's a big opportunity cost there. While you have money tied up in one or more of the 4 banks, you could have had that money invested in something that was rising in value - which would/should drag the share price of that investment up too - sooner or later.

In summary, our 4 big banks are NOT going broke. You won't lose your entire investment by investing in them. Our Australian Federal Government will ensure that they do NOT fail. But they are very unlikely, in my opinion, to be among the best opportunities in our market over the next few years.

04-Jan-2021:  Update:  I still don't like the big 4 banks, and I still prefer MQG over those other 4 banks - for the reasons I outlined above, but I don't hold any of those 5.  However, looking back at their share price performance over the past 6 months NAB is up +22.4% and has outperformed ANZ (+20.1%), CBA (+17%), MQG (+14.7%) and WBC (+5.9%).  So Kudos to those who suggested that NAB did indeed have more upside, because they did - over 6 months at least.

Despite that - I still do not like the banks - except for Macquarie (MQG) and I still think NAB is the worst of them.  Congrats to those who did buy NAB back then, because a +22.4% capital gain in 6 months is not to be sneezed at - it's a very good return.  My point was, and still is, that I personally felt there were better opportunities with companies and sectors that didn't have the headwinds that the banks were going to have and are going to have - and I meant over the next 2, 3 or 5 years, probably more, so in that respect I guess it's still early days.

If you look at a few of the companies I've backed - that have been on my scorecard during all of the past 6 months - my higher conviction companies that I've held larger positions in - they have mostly done better than the banks.  Examples are MND (+25.6%), NWH (+67.2%), GNG (+71.8%), SRG (+70.8%), SXE (+35.7%), SXY (+40%), ARB (+65%) and RVR (+300%).  I have trimmed many of those position right down now as I don't consider the risk/reward equation to be as favourable now as it was then, however MND & NWH are two examples of companies that have performed well and that I still have large positions in (relative to the sizes of the other positions on my scorecard, and in my real life portfolios as well).

Even some of the beaten up LICs have performed better than the banks, particularly the ones that don't usually hold banks in their own portfolios, like FOR (+55.6%), WQG (+24.2%), WMI (+53.3%), WGB (+27.3%), CDM (+39.2%) and SNC (+36.8%).  CDM do hold MQG but it didn't do them any harm.

Obviously I'm cherrypicking here, and there are other companies that I hold that have certainly underperformed - mostly gold producers who have seen their share prices decline during the recent rotation into "recovery plays" as the positive COVID-19 vaccine news caused a big positive sentiment shift in former unloved sectors.

And some other positions that I hold have performed much in line with or a little worse than the better performing banks, companies like BPT (+19.7), S32 (+17.4%) and DOW (+22.2%).

However, looking back at my highest conviction companies six months ago, the majority of them have outperformed the banks - in share price appreciation terms as well as in total shareholder returns terms (TSR, which includes dividends/distributions AND capital gains) - and I expect to be able to report similar results in another 6 months, because I still think there are better companies in which you can earn better returns than in our four big banks at this point in time (in the banking sector cycle).

And I still think NAB is the worst bank, even though they have outperformed the other banks in SP appreciation terms over 6 months.

If I was forced at gunpoint to buy a bank, it would be MQG.  The best of the big 4 is CBA, with the other 3 a long way behind them.  But I'm very happy to not hold any banks.

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