Page 24 - DIY Investor Magazine - Issue 27

VALUE MATTERS EVENTUALLY
Financials remains one of the cheapest equity market sectors; they jumped sharply in price following the positive news around vaccines in November, as the sector is one of the biggest beneficiaries of economies opening up over the course of this year and into 2022 - Polar Capital Global Financials Team.
Their earnings are sensitive to economic activity; therefore the improving outlook has driven the rally as confidence in the earnings outlook for the sector over the next couple of years has risen sharply. This should not be a surprise.
At this point of the cycle the sector has discounted a much worse downturn than has actually happened, thanks to government and central bank actions to reduce the economic impact of lockdowns and changes in spending patterns.
Looking back over previous recessions or market falls, having discounted the bad news financials have always outperformed almost immediately, whether it was the failure of LTCM in 1998, the TMT bubble in 2000, Iraq war in 2003, the global financial crisis, the Eurozone crisis or the UK referendum in 2016.
This time is no different and history suggests there is much further to go.Earnings for the sector are forecast to be up 38.9% in 2021 and 10% in 2022, led by the recovery in the earnings of bank shares as new accounting rules have forced banks to make loan loss provisions much earlier in the cycle than previous downturns.
‘CONFIDENCE IN THE EARNINGS OUTLOOK FOR THE SECTOR OVER THE NEXT COUPLE OF YEARS HAS RISEN SHARPLY’
As a result, these provisions were set when the outlook in the middle of 2020 was much cloudier and will prove to be too conservative. For example, under its base case forecast JP Morgan has stated it has excess provisions of $10bn.
In fact, the surprise of this downturn was that last year banks’ shares, as illustrated by the chart below, underperformed by more than they did in the global financial crisis, when banks were failing, and confidence in the financial system collapsed.
Today it is very different. Bank balance sheets are strong and they have been part of the solution, providing a conduit for government-guaranteed lending to support businesses and allowing many individuals and businesses to take payment holidays.
‘GLOBAL FINANCIALS HAVE RISEN BY 55% OVER THE PAST FIVE YEARS VERSUS UK FINANCIALS’ RISE OF ONLY 17.5%’
S&P500 VS KBW BANK INDEX IN 2008/20091
Source: Bloomberg, 31 December 2020
DIY Investor Magazine | Mar 2021 24