The Case for Banks in 2019

Financial services are a big part of the modern economy, but are banks a good investment? They're certainly profitable, and these days very unlikely to fail, but mostly unloved. What this means is that they churn out cash, but their share prices trade at modest multiples of current earnings.

To some extent bank share prices move around with interest rates. The general view is that when interest rates are rising they make more money, as they charge their customers (people who borrow to buy houses, cars, and things on their overdrafts and credit cards) more, but delay paying their depositors' extra interest.

Large bank stocks in the US market (we own JP Morgan) have underperformed the S&P 500 sharply in recent weeks due to a decline in forward interest rate expectations. The Fed was talking about multiple rate hikes in 2019, and then it changed its mind. In the long run what matters more is benign credit conditions. In other words, people doing well and not defaulting on their loans. Finally, banks lend to businesses, so they do well when the economy is expanding and there are lots of mergers and acquisitions going on.

Here in South Africa credit conditions are slack and confidence is low. Hopefully sentiment levels will perk up if the election goes off well in May. Firstrand is attractive, and so is Discovery. Capitec continues to do well, but is probably fully valued.

One more thought. All banks are becoming more efficient. If all goes well, another earnings kicker in years to come will be the greater use of technology and online channels to lower costs. The cheque book pictured below is a thing of the past.