Time to buy banking shares?

MAYBE (NOT) : RISK OF A RATING DOWNGRADE REMAINS

While banking stocks are not expensive, they’re no longer as cheap, relative to historic valuations.

The outlook for industry has improved in line with that of the economy in recent weeks. And while banking stocks are still not expensive, they’re no longer as cheap, relative to historic valuations.

But their performance continues to hinge on improved economic growth and SA maintaining its sole remaining investment grade rating.

Banking stocks, regarded as a bellwether for the economy, rallied in December following Cyril Ramaphosa’s election as ANC president. The banks index closed more than 8% higher in the immediate aftermath, as he’s widely regarded as market-friendly.

“Cyril Ramaphosa’s win at the ANC elective conference was a massive boost for confidence for South Africa, and in turn the banking sector. It signifies the potential for improved governance,

growth and investment in South Africa which translates to improved lending environment for the banks,” said Neelash Hansjee at Old Mutual Equities.

PSG Wealth’s Adrian Cloete explained that banking shares benefited from a downward move in the 10-year bond yield and a stronger rand following the conference.

This, due to a strong inverse correlation between the bond yield and banking stocks and a stronger rand, should lead to an improvement in the inflation outlook and provide room for interest rate cuts, which would lift confidence.

As a result, banking shares have moved from being relatively cheap toward more of a fair value as reflected in current price to earnings (P/E) ratios. A P/E ratio is a valuation method used to compare current share prices to earnings per share, with a high P/E pointing to higher earnings growth.

Cloete said underlying full-year earnings growth prospects (amid

a challenging macroeconomic environment) remain muted – in the low single digits for the majority – but the conference outcome has removed some uncertainty.

Nedbank’s 2017 earnings are expected to be flat, with Barclays Africa Group’s forecast at 3% and FirstRand, which has a June yearend, at 5%.

Standard Bank’s 2017 earnings are expected to be around 9% higher.

The banks index delivered returns of 23.03% in 2017, outperforming the All Share at 16.62% and Top40 at 18.69%.

Hansjee said there’s reason to be cautiously optimistic regarding banking shares’ performance but warned there’s still a “long road ahead” in terms of politics and the risk of a sovereign rating downgrade remains.

Cloete, too, warned of the risk of SA losing its sole remaining investment grade rating from Moody’s, which would trigger an exit from world bond indices and forced selling of domestic assets by some investors.