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It’s the question on every investors’ lips – should I be buying into the banking sector?
OK, well maybe that’s an exaggeration. But after the recent carnage in the sector – Barclays (BARC) fell 9.2% last week, while Royal Bank of Scotland (RBS) dived 13% – there must be a lot of people out there wondering whether now’s the time to get in.
After all, these are big blue-chip stocks, high street names, with dividend yields of more than 7% in some cases. How bad can it be?
But I’d suggest holding back. Because bad as it is, things could still get very much worse for the banks…
Not so long ago, the pundits were lining up to suggest getting back into financials, driven partly by Anthony Bolton of Fidelity’s proclamation that the financial sector was looking interesting again.
And after last week’s plunge, some of the banks look very tempting indeed. According to Bloomberg, Barclays now trades on a forward p/e of below seven, and yields 6.5% or so, while Royal Bank of Scotland trades on a forward p/e of below six, and yields nearly 8%.
But taking a look at the FT’s weekend Money section, it seems that the City’s enthusiasm for financials was short-lived.
F&C’s Makis Kaketsis reckons investors should cut exposure to banks and avoid the sector for at least a year. Carla Antunes da Silva at JP Morgan points out, quite rightly, that “banks keep saying it will be fine, but then taking hits, and no one knows where it will end.”
Meanwhile, Robert Law of Lehman Brothers makes what is probably the strongest argument for avoiding banks, saying “I have never seen banks do well when property values are in decline. Stocks look weak but are not cheap on a price-to-book ratio. It is too early in the deterioration of the sector to start buying.”
And of all the stocks in the sector, Barclays and RBS seem to be the ones that the pundits are most concerned about. Neither bank has reported since the credit squeeze became public in August, and as the FT points out, both banks have been “active in originating, structuring and trading structured products based on US mortgages”, which is the area that has been forcing all the writedowns at US investment banks.
Citigroup analysts have also pointed out that on some measures, Barclays and RBS are the “least well-capitalised banks in Europe.” RBS is particularly overstretched, due to its purchase of ABN Amro. That’s one battle that Barclays must now be thanking its lucky stars it lost.
If a bank does breach its capital requirements, it would potentially need to issue new shares to raise more capital. Barclays is still buying back its own shares, which suggests it has plenty of money, while RBS has said it won’t need to issue more shares.
But the broader question remains. As Roger Bootle points out in this morning’s Telegraph, “best estimates of the scale of the banking system’s total losses from US sub-prime mortgages are in the $150bn to $200bn range. The big banks have admitted to losses of $30bn. Accordingly we can be sure there is much more to come.”
Moreover, “these estimates are based on what has happened in the US housing market so far.” And as we’ve been saying for a while, conditions in the market look set to get much worse before they get better.
As James Ferguson told readers of his Model Investor email service on Friday, by some measures, it’s more than possible that every sub-prime mortgage written from 2005 onwards could end up defaulting – even if US interest rates are slashed further.
With that kind of uncertainty hanging over the likes of the sector, I reckon it’s far too early to start bargain hunting now.
Turning to the wider markets…
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In London, the FTSE 100 index of leading shares ended a third day of losses 77 points lower on Friday, at 6,304. Rio Tinto topped the risers on continued takeover speculation but peers in the mining sector, inlcuding Vedanta Resources and Antofagasta, gave up Thursday’s bid-fuelled gains to end the day in the red. For a full market report, see: London market close.
On the Continent, the French CAC-40 tumbled as the European Commission announced cuts to its 2008 eurozone growth targets; the index was down 107 points, at 5,524. In Frankfurt, however, the DAX-30 was just 7 points lower, at 7,821, despite a weak opening on Wall Street.
Across the Atlantic, stocks ended a poor weak with another day of losses. Revelations of Q4 loan losses of as much as $600m from bank Wochavia hurt investor sentiment, although the bank itself ended the session in positive territory thanks to a late rally. The Dow Jones was 223 points lower, at 13,042. The S&P 500 was 21 points lower, at 1,453. And the Nasdaq slumped 68 points to end the day at 2,627 as tech stocks – including Google – fell.
In Asia, the Japanese Nikkei was down 386 points to 15,197 on the weaker yen. And in Hong Kong, the Hang Seng was 1117 points lower, at 27,665.
Crude oil had fallen 63c to $95.69 and Brent spot was down to $93.09 in London.
Spot gold fell to its lowest level in almost a week today – dipping to $813.70 – as investors took profits on last week’s rally. And silver had fallen to $15.16.
In the currency markets, the pound had fallen to 2.0765 against the dollar and 1.4230 against the euro as investors backed off relatively high-risk carry trade positions. And the dollar was at 0.6851 against the euro and 110.47 against the Japanese yen.
And in London this morning, Pearl Group looked a step closer to buying UK insurer Resolution after rival Standard Life abandoned its bid. Resolution refused to raise its offer above Pearl’s all-cash $4.93bn bid, saying that the takeover would not create ‘sufficient value’.
Finally, our recommended articles for today…
How to profit from market turmoil
– When shares are ricocheting around like balls in a pinball machine, the easiest way for the typical retail investor to play a mean pinball is via spread betting. Tim Bennett explains how to get started in this MoneyWeek article, just available to non-subscribers: How to profit from market turmoil
The winners and losers in these times of transition
– Although nervewracking and painful at times, the repricing off too-cheap assets and disclosure of losses was long overdue. Brian Durrant suggests which investments will prosper in this new investment climate – and which will remain in the doldrums for the foreseeable future: The winners and losers in these times of transition