Betting against the bank. ‘Widow-maker’ trades are making a comeback

In the hedge-fund world, betting against the big Australian banks is known as a “widow-maker” trade. This is finance slang for an investment move that looks sensible in theory, but has a long history of inflicting hefty losses on those who try it.

For years, the “bearish” case against investing in Australian bank shares has been built on the claim that our housing market is a debt-fuelled bubble, and that this leaves the banks that prop it up vulnerable. For years, betting against bank shares (especially the biggest, Commonwealth Bank) has generally not paid off.

Yet lately, banking bears have been growing in number, and you can see this in the number of people “short-selling” (a trading strategy where people bet on, and profit from, a falling share price).

Short positions in Commonwealth Bank have jumped from about 0.6 per cent of its shares last September to more than 2 per cent, according to the website Shortman, which draws on data from the Australian Securities and Investments Commission.

Short positions in Westpac, the second-largest mortgage lender, have risen a similar amount over this period to slightly less than 2 per cent.

That is hardly the only sign of more people taking a more gloomy view on banks. Much of the analyst commentary on banks has also been discernibly negative lately, understandably focusing on the risks from a slowing home loan market and the potential end of a multi-decade boom in property prices.

These risks are very real. For all this negativity towards banks, however, another thing is equally striking. Our banks are still making huge piles of money. CBA delivered a record $11 billion last year for example, with a very healthy return on equity of 14 per cent.

So how come CBA is churning out its biggest ever profit, yet more people are betting against it? Is it just the weak housing market, or are there other reasons why the market is down on banks?

To be fair, vocal debate about whether Aussie banks are overvalued is nothing new. Markets depend on people having different points of view about what something’s worth. It’s also common for a company to be churning out bumper profits (such as CBA) even as future profit growth looks more challenging.

Lately, however, the ever-present debate about whether Aussie banks are over-valued has come into sharper focus.

Like many issues in banking, a lot of it comes back to housing – the biggest source of Australian bank loans.

The great mortgage slowdown – which accelerated when Labor moved to rein in housing-investor tax breaks in the May budget – was a dominant feature of the results announced last week from Commonwealth Bank, Westpac and ANZ Bank. National Australia Bank will deliver an update on Monday, after it last month disclosed a 15 per cent slump in loan applications in the June quarter compared with the March quarter.

While it’s obvious home lending is slowing, however, no one knows by how much, or exactly what this will mean for banks.

Co-chief executive at fund manager Alphinity Andrew Martin says what we’ve seen from the banks over the past week doesn’t really resolve the debate.