Should We Bank On Banks?

Those stocks that hitherto have created maximum wealth for retail investors are the ones that have corrected the most. Amidst the uncertainty surrounding the most important sector for the financial system of India, such stocks suddenly have started looking attractive after a vertical fall. Yogesh Supekar and Karan Bhojwani discusses the pros and cons of taking exposure to banking stocks in such a fluid market situation. 

The financial sector has always been the favourite of both institutional and retail investors. The reasons for the sector being extremely popular so far were simple: the financial sector mimicked the economic growth completely; the sector being a leveraged one offered superior growth opportunity and provided a high return on equity or return on capital for the investors; and the untapped opportunities lured new players to operate in the sector, thus increasing the size of the sector exponentially. In this scenario, the banking industry makes for a crucial part of this highly leveraged financial sector.

If we look at the reasons why the financial sector was hitherto so popular, one may find cause to worry in terms of the sectoral prospects because the very growth levers that made the sector attractive amongst the investors seem to have vanished in view of the virus pandemic-influenced lockdown in the country as well as the world. Forget growth, even survival is at stake for a majority of financial companies, including banks. Thus, how does one evaluate the investment prospect when the situation is as fluid as today? The economy is at a standstill and the banking operations nationwide are impacted.

We know for sure that both growth and profitability will be negatively impacted in the coming days. The asset quality can be expected to worsen. Some of the listed state banks are already reporting losses due to higher provisioning. Amidst all this pessimism how on earth can one buy financial stocks, and especially bank stocks? That said, the recent sharp, almost V-shaped recovery in markets, including banking stocks, has taken many by surprise. Was the vertical fall overdone or is the recovery overdone – only time will tell. However, no one can deny the opportunities presented in the current market scenario, especially as regards the financial and banking stocks.

Past Sectoral Recoveries

If we look at the commentary made by various market participants and the CEOs of major corporations, the one thing they agree on is that the current situation is unprecedented and that none of us have seen anything like this before. If the situation is really unprecedented does it mean that the markets will fall to a similar extent as they did in all the previous crises situations? For instance, the dotcom bubble when it happened was unprecedented and so was the great crisis of the year 2008. History suggests that markets recovered from both the dotcom bubble and the financial crisis – it is only a matter of estimating how much damage is made to the economy and the markets and how much time it might take for both to recover. The financial crisis of 2008 impacted banks the most. The most interesting aspect to note here is that it was the banking sector indeed that recovered the fastest.

As seen from the table above, banking stocks along with auto stocks staged a massive recovery once the crisis was under control. The banking index went on to deliver an impressive 39 odd percentage CAGR returns over the next three years. Within the banking space, private banks staged a more impressive recovery and were able to create massive wealth for the investors.

Banks’ Relative Performance

The banking index has underperformed the key benchmark index and even the broader markets on an YTD basis. Nifty Bank is down by nearly 35 per cent on an YTD basis, Nifty Finance is down by 30 per cent while Nifty PSU Banks is down by nearly 46 per cent. The only other sectoral index which underperformed Nifty Bank was Nifty Realty, which was down by approximately 36 per cent on an YTD basis. Clearly enough, banks have underperformed the most in the current fall even as pharmaceuticals shined with Nifty Pharma inching up by close to 14 per cent on an YTD basis with the Sensex falling by 23 per cent and Nifty by 24 per cent.

This phenomenon of underperformance is not restricted to the Indian markets. Globally too the banks underperformed as is represented in the table below.

Recovery Triggers

The current virus pandemic is a unique problem faced by the global economy. Its solution also has to be a global one. Even though as of now all the countries are looking inwards and attempting to tackle the problem within their respective boundaries, a global response will soon be required to tackle it. The global response could be in the form of financial aid to countries and providing soft loans to manage the crisis. Already an unprecedented amount of aid has been announced by individual countries with Germany, USA, Italy and Spain being the most aggressive.

The interest rate in most of the developed world is already at zero per cent. The stimulus timing and quantum has created such an enormous level of liquidity in the global markets that there is confidence amongst the market participants about the survival of the banks. The recent rally can be attributed to the stimulus announced by the western world and policy actions taken by the US Fed. What the latter has done is to boost confidence by taking measures to support the economy. Its Indian counterpart, the Reserve Bank of India (RBI), has also been not far behind and has taken baby steps and a calibrated approach to ensure that the financial system and banks remain fully functional and operational while being solvent.

Nifty Bank : Technical Perspective

A Pied Piper in many respects, Bank Nifty is a very important index for the overall markets. It has had the potential to single-handedly take the market up or down. And this has been clearly visible for the whole of last year through how this index has outperformed, thereby helping the Nifty reach greater heights. However, in the last one month or so, the inverse seems to have been played out. Yet, some encouraging signs have started to emerge from the weekend of April 17, 2020 with Bank Nifty gaining about 3.86 per cent as compared to 1.7 per cent registered by Nifty, thus outperforming the Nifty.

On Friday, Bank Nifty witnessed major recovery and the key catalysts for this up-move were RBI’s liquidity measurers and short covering. Bank Nifty also managed to close above the high of 20,324 posted on April 8, 2020 and there is a pennant breakout visible on the daily time scale as well. The action of the moving averages is sometimes a good indicator of the market trend. Even though this study is lagging in nature it gives you a reasonable idea about the supremacy of bull or bear.

The short-term moving averages i.e. 20 EMA, since the index started falling from the highs of February 13, 2020, have been sloping downward. However, with the index bouncing back with greater strength in the last couple of trading sessions, the price has crossed above the 20 EMA and also its curve has turned flat and changed its course. On the upside, resistance is around 21,462 which is swing high of March 27, 2020 followed by 22,050 which is 38.2 per cent of the recent impulse fall. On the downside, 19,500-19,700 is a crucial zone to watch out as support.

Why private banks

Private banks have always traded at a premium to its state bank counterparts.Strong liability profile and sound asset quality - are key to private bank fethching a higher premium to its peers. Large private banks such as HDFC Bank has shown healthy growth in advances and deposits and has reflected comforting asset quality with GNPAs at 1.4 percent. The bank continues to increase its marketshare.

Axis Bank has shown steady loan growth amidst economic slowdown and has shown good momentum in retail business. The improvement in margins is expected for Axis Bank once the crisis situation normalise. After the recent fall there is no doubt that the valuations have become attractive.

City Union Bank is well capitalised bank with Tier I ratio at 14.9 percent. The bank has shown consistency in earnings and has reflected better return ratios. The deteriorating asset quality remains a concern though. For ICICI Bank the retail portfolio has been growing well and the credit cost has been declining. The improvement in asset quality suggests sustained strong performance in the counter for coking quarters. 

The bank has healthy loan book and strong digital growth can be expected to fuel growth in the long run for ICICI Bank. Different private banks have their unique strengths but what is common for private banks is that each of the successful ones are expected to increase market share, have healthy loan books, asset quality is superior when compared to state banks, digital growth startegy is in place and most importantly large private banks are well capitalised with excellent operational performance.

Only time will tell how each of these bank survive the covid-19 battle , however valuationwise the banks are way cheaper today than they were at the beginning of the year. Any further correction in private banks make the counters more attractive for long- term investments purpose. 

Bull Trap 

The expression ‘bull trap’ describes a technical price pattern of a stock that wrongly convinces some investors to believe that a bull rally is underway and thus it is the right time to buy. It usually occurs in a down-trending market and can often be very convincing in real time with its indication of a reversal being underway. However, this is a false signal and the market soon returns to a downtrend, thus trapping the ones who thereafter need to sell to get out, even at a loss. Bull traps usually occur during bear markets. However, they can even occur during earnings announcements or news events when moves to the upside are short-lived on a chart.

Many traders get caught in a bull trap simply because they have a fear of missing out (FOMO) on a new uptrend and so they buy the first rally too early. The best way to handle bull traps is to recognise warning signs ahead of time such as low volume breakouts and exit the trade as quickly as possible if a bull trap is suspected. Stop loss orders can be helpful in these circumstances, especially if the market is moving quickly, to avoid letting emotion drive decision-making. Traders can have better possibilities of avoiding such a ‘trap’ by waiting for additional confirmation signals and follow-through after a reversal, gap up, or breakout along with the support of other technical signals.

Conclusion

It is yet unclear what the impact of the pandemic on the economy will be, and in turn on the banking business and profitability. What is clear though is the intention of various governments. While calculating the trade-off between saving lives and putting economy back on track is what is keeping the decision-makers busy, countries such as Russia and Germany have already announced that the outbreak is manageable. In the US there is every intention to reboot the economy and back home in India the lockdown is expected to be lifted in a gradual manner. Even as the global economy currently suffers and shows signs of getting restarted sooner than later, in spite of the uncertainty surrounding the spread of the virus, the challenge remains for investors to construct a portfolio that can beat the markets. The recent phase of recovery has shown that the markets have shifted from the risk-off to the risk-on mode a little bit. Fresh long positions are seen in high beta stocks. Banks, in that respect, are high beta stocks and their businesses are leveraged. When things go down south, banks could be the ones bearing the brunt the most but the same banks recover rapidly once the crisis shows signs of stemming down.

The markets are forward looking and could be discounting the post traumatic growth for banks. Investors should therefore choose leaders in the banking industry and continue to give preference to those banks with higher capital adequacy and the ones that have shown improvement in asset quality. Banks with quality balance-sheets and the ones which are optimally using the digital strategy to acquire new clients and service them digitally may see their profitability improve going forward.

There is a good chance that the private banks may continue to gain market-share from the PSU banks in the coming quarters. With a clear understanding that we may not be totally out of the woods yet and the current recovery could well be a bull trap, investors can buy select quality private banks in a staggered manner and avoid taking any position using leverage. Also, the weightage of the banking sector in the overall portfolio should be revisited. The dominance of banks in a diversified portfolio could be tamed at least until we are totally out of the current crisis. Bank on banks for outperformance only if you can differentiate the quality ones from the poorly managed banks!