The adage “as January goes, so goes the year” bodes for a flattish 2011. The FTSE 100 will be largely range bound; bumping along between 5,700 and 6,300. Undoubtedly, corporate earnings have recovered. But what has been noticeable this month is that firms beating City estimates aren’t being rewarded as much as those missing them are being punished. In short, sentiment is turning down.
In the coming months, investors will have to contend with fears of more sovereign defaults and the potential for unpleasant surprises from a cooling Chinese economy. Then there’s rising inflation, unemployment and interest rates.
The market should be able to handle these headwinds as long as the Federal Reserve follows through on its signals to print yet more money. Further out, though, the $64m question is whether a debt crisis can be solved by issuing more debt.
So what does all this mean for the banking sector? Well, I see higher oil, commodity and food prices pushing interest rates up. That will be bad news for borrowers and lenders. Indeed, it could trigger a slew of personal and business bankruptcies that could send write-offs soaring again. This is one reasons why the US Treasury and European Central Bank are asking for more stress tests to be conducted.
However, the sector’s main Achilles heel is its interdependency. Another Lehman Brothers-style collapse will expose the fact that counter-party risk is, frankly, colossal. Sure, governments have so far bailed out the industry, but this is about to end. For instance, from 2013 onwards bondholders will be forced to take a haircut on any restructuring of European sovereign debt. This is the main reason I consider banks to be a no-go zone – and that includes Barclays.
Undoubtedly, the organisation is in better shape than it was in 2008, yet it is faced with two major problems. Firstly, its balance sheet still contains too much hidden risk – not least its exposure to loans in fragile countries such as Britain (£227bn), Ireland (£6.6bn), Spain (£34bn) and Portugal (£8.9bn). I also have concerns over the creditworthiness of its £7.8bn funding of Protium, a Cayman islands vehicle that was created to flog off a batch of “illiquid” ex-Barclays assets.
Barclays (LSE: BARC), rated a BUY by Oriel Securities
But that’s not all. Many of the firm’s assets are duds, given they don’t currently earn returns above their cost of capital.
In essence, by holding onto them the bank is destroying shareholder value. This is why Barclays’ shares appear cheap, trading on a 13% discount to their net tangible assets (NTA) of 345p per share.
Not surprisingly, CEO Bob Diamond is furiously working behind the scenes on plans to lift equity returns from the paltry 6.7% to 15% by 2013. Since most of its competitors are also trapped in the same straitjacket, this seems very ambitious.
So, with the bad debt cycle nowhere near dead and buried, I would rate the stock on a 0.7 times NTA, or about 245p per share. Moreover, I’m not the only one who thinks Barclays is a sell. DE Shaw, one of the world’s top hedge funds, has recently taken a £97m short position on the stock.
Recommendation: SELL at 295p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments