High dividend paying bank stocks have been a rock for DIY super investors, providing strong income and franking credits. In a global investment environment struggling with low interest rates it has been a highly successful option. But markets constantly change, and what has worked in the past may not always work.
The AFR has a story today on Lazard fund, suggesting that the banks are heavily overweight, at 42% of the index, which is much higher than other booms in recent history:
"Osborn's lesson as a fund manager with almost 30 years experience is from recent history. The faith of investors in the banking sector is the most recent and extreme instance of exuberance in Australia's stock market. This has seen its concentrated stock market index, and the passive investors that track it, load up at the top.
"Around the world, the biggest company in the S&P500 is only 2 or 3 per cent of the index. There's a lot of depth so it's a good measure of performance," he says.
"But in Australia, there have been three times in the last 10 to 15 years where we think the index has been wrong and as an investor you don't want to be there".
"The first was when the TMT or technology, media and teclos made up 37 percent of the ASX 200 in March 2000. At the time News Corp alone accounted for 20 pert cent of the stock market index while pie in the sky stocks such as Davnet and E-Corp captured the imagination of get-rich-quick investors.
"The problem with the TMT bubble is there were little to no earnings. So when it came down it came down very badly for some".
In 2008 it was the once in a generation mining boom that led materials to account for almost 39 per cent of the index. TMT had declined to less than 10 per cent.
"This was the opposite [of the TMT bubble] – there was a lot of money. Companies were earning well in excess of what they should have earned and it was real money – so people were prepared to pay up."
Now we're in the most extreme manifestation. As at March, banks accounted for almost 42 per cent of that index while materials and energy has fallen back to account for 16 per cent.
With the banks making up such a large portion of the index, Osborn is warning that buying the index isn't the safe bet that it appears.
"Like the other times, you need to be a bit smarter and be different from the index because we believe that the index is the risky bit," he says.
Osborn's view is that the banks are excessively valued, and his partner Dr Hofflin is presenting to current and future investors in the fund, questioning whether the extraordinary growth in credit that has fuelled the bank's profit growth is unsustainable."
The banks certainly have strong earnings. But they are also a property play -- because much of their business is mortgage lending -- and few would argue that the residential property market is not overheated. It all looks horribly concentrated, meaning that the risks are high. Diversification is the best option.