Big four banks face earnings reality check

Spotlight on the big banks

In this week's edition of IG Macro Intelligence, we examine ASX-listed financial stocks and the potential sector rotation ahead.

Is the "great rotation" finally here?

The new financial year has sparked discussion about the so-called "great rotation", with analysts expecting materials stocks to outperform financials over the next 12 months. Financial stocks have delivered solid performance over the past 12 months, with the Australia 200 (ASX 200) Financials Index up almost 16%, nearly double the gain of the broader Australia 200 during the same period.

Australia 200 one-year chart 

• CBA

Meanwhile, the materials sector has delivered less than 1% return over the same timeframe.

Jun Bei Liu from Ten Cap identifies emerging valuation convergence between the sectors. She believes if the anticipated sector rotation materialises, Commonwealth Bank of Australia (CBA) faces significant downside potential, though she's not yet ready to make that call definitively.

Liu argues that resources valuations appear attractive, pointing to this earnings season where companies are receiving upgrades at current spot rates. She notes that resource company earnings are rising, but analysts haven't updated their forecasts as they continue expecting iron ore prices to decline, which hasn't happened. Liu expects resources companies will receive earnings upgrades while maintaining strong dividend payouts, contrasting this with banks that may face earnings downgrades.

CBA daily chart

Commonwealth Bank of Australia shares have continued to defy the naysayers, reaching record highs of $192 per share in the past month. CBA has risen almost 30% over the past 12 months, more than three times the return of the Australia 200. But if analysts are correct, it's due for a significant pullback.

CBA historical trends and price targets

The passive flow phenomenon driving CBA higher

Fergus Humble from Morgans explains the persistent strength in CBA shares, attributing the momentum to structural market forces rather than fundamental analysis. He suggests there are numerous theories about why the stock continues rising, but believes the primary driver is passive investment flows. Humble points to index exchange-traded funds (ETFs) that are required to maintain their CBA weightings, forcing them to accumulate more CBA shares while potentially selling other holdings. This creates sustained buying pressure regardless of valuation concerns.

He admits that despite advising clients to sell CBA at $130 and later at $140, the stock has continued its relentless climb, making it extremely difficult to time any potential reversal.

• Analyst warnings versus market momentum

Not one analyst surveyed by Refinitiv suggests buying CBA at current levels, with the average recommendation a 'Sell' and a price target of $116.79, suggesting CBA could fall around 33% from its current level.

Morgan Stanley analysts are underweight CBA but have raised their target price to $129, expecting the lender's FY results, due on 13 August, will come in line with market expectations.

MPC Markets CEO Mark Gardner calls the continued run-up in CBA "ludicrous". However, ASX Tradewatch data show shares in a long-term uptrend as confirmed by multiple indicators, suggesting investors don't want to bet against momentum. Specifically, both the 20-day and 200-day moving averages are sloping upwards, signalling the stock can continue to rise in both timeframes.

CBA buy/sell indicators and analyst projections

• Where do the other big banks stand?

ANZ, Westpac, NAB and Macquarie all report earnings out-of-cycle, so it will be some months before investors can properly look under the hood.

But Morgan Stanley estimates major bank cash profits fell by an average of around 2% in the June quarter, against what it calls "the backdrop of a competitive but stable operating environment". Analysts say investor expectations are optimistic for Westpac but quite cautious for NAB, with revenue growth and margins the key earnings drivers to watch.

Australia 200 market summary

• ANZ

Meanwhile, Citi analyst Thomas Strong is waiting to see whether what he calls the "mother of all dams" is the catalyst for a sustained rotation by investors out of Australian bank stocks. He notes China's announcement of a dam on the Yarlung Tsangpo river was the spark for the recent shift by investors from banks into resources, but it remains to be seen whether this move can be sustained. ANZ is Strong's preferred play among the banks.

Analysts are more positive on ANZ than CBA, with the average recommendation on the stock a 'Hold' according to Refinitiv. However, the average price target at $28.27 is around 7% lower than current levels.

ANZ historical trends and price targets

• NAB and Westpac

Macquarie puts the recent momentum in banking shares down to offshore investors, who bought $2.7 billion worth of ASX banking shares in the last six months, the most since March 2020. Macquarie tips the flows could now reverse as US capital returns rise and super funds look outside Australia. The broker is neutral on NAB with a $35 target price, among the highest targets for the stock.

Analysts are broadly negative on the outlook for Westpac, with the average recommendation also a 'Sell', according to Refinitiv.

NAB buy/sell indicators and analyst projections

Westpac historical trends and price targets

• Macquarie Group

Macquarie Group shares have risen just over 4% in the past 12 months and were sold off last week amid a drop in Q1 profit and news CFO Alex Harvey is stepping down at the end of the year after almost 30 years with the group. Macquarie has also recorded its first-ever remuneration strike, with more than 25% of shareholders voting against salary plans for the first time.

Macquarie daily chart

But analysts are upbeat about the outlook for Macquarie, with the average price target $227.23, a 5% premium from current levels, while the average recommendation is a 'Buy'. ASX Tradewatch data also show shares are in a near-term uptrend.

Ord Minnett believes the remuneration strike is a "tricky" situation for Macquarie as it balances compliance across more than 200 regulatory entities and retaining staff with lower compensation packages. It views the retirement of long-standing CFO Harvey as no surprise, supporting the view that CEO Shemara Wikramanayake is not going anywhere at this stage. The broker has an accumulate rating and $245 target.

Luke Laretive from Seneca Financial Solutions explains that Macquarie operates with two distinct business segments: one providing stable, consistent growth, and another that's highly volatile. The volatile division typically drives the bank's headline profit variations from year to year, sometimes delivering exceptional returns while occasionally acting as a drag on performance. However, he notes that Macquarie's track record shows they "more often than not get it right" and continue to generate substantial profits.

Macquarie buy/sell indicators and analyst projections

Why retail investors won't sell their bank shares

When it comes to the overall outlook for financials, Mathan Somasundaram from Deep Data Analytics attributes much of the banks' resilience to retail investor behaviour.

He explains that many retail investors, particularly those holding CBA shares, have owned their positions since much lower price levels and are reluctant to sell due to capital gains tax implications. This creates a natural floor of support, as these long-term holders remain largely indifferent to short-term price movements.

Somasundaram suggests that for retail investors, the government guarantee backing major banks provides confidence regardless of share price volatility, making them willing to hold their positions through market cycles.