How many times in the last few weeks have you been told that the banks’ shares are dirt cheap?
The relative valuations of most banks, as gauged by their price-to-tangible book value and price-to-earnings ratios, offer a very attractive entry point, many observers argue. Moreover, the shares of certain banks could be a bargain because they trade are at much lower levels compared to post-credit crunch highs, although developed economies have healed.
I have been stuck with a bank stock for about six years. Not only had I bought it at a 50% discount vs its previous high, but trading multiples were the lowest ever on record. As a result, I had to average down my investment over time in order to record just a poor, rather than a dreadful, performance. Luckily, that holding made up just 3% of my portfolio in those days — diversification always pays off.
Banks And Miners
Elsewhere, I have heard bullish comments about the mining sector — it’s cheap, trading multiples are low, it offers compelling value — so now I am going to tell you why neither the banks nor miners are likely to deliver terrific returns for some time.
The first warning comes from the macroeconomic environment, where low interest rates dominate and any increase in rates is several quarters away both in the US and in the UK. The household’s overall indebtedness in the Western world isn’t exactly under control, and hinders purchasing power, while there’s not much inflation kicking around, so Central Banks — the Federal Reserve and the Bank of England — have little room for manoeuvre. In Europe, the ‘Draghi Put’ has pushed down yield curves, and deflation is a real risk. So, forget about any hawkish signals there.
A top-down approach suggests the banks are not out of the woods yet, and fundamentals also point to more pain on the road to value. Barclays and Lloyds, for instance, have forward P/E ratios of 12.3x and 12.4x, respectively, and trade at a discount to the market. If I were ever to invest in the sector, I’d rather take on more risk and place an opportunistic bet on either Royal Bank of Scotland or Standard Chartered, hoping their restructuring plans work out.
Betting On A Bounce
A few miners have bounced back since mid-December, with Rio Tinto and BHP Billiton up 17% and 20%, respectively.
Both Rio and BHP have greatly outperformed Anglo American and Glencore over the period. Still, Rio trades at 12.1x forward earnings, while BHP’s forward P/E stands at about 14x. Still cheap, I hear you say!
While it’s possible that the sector will appreciate 10% or more to the end of the year, the risk is that China’s growth will continue to disappoint, which doesn’t bode well for the entire mining sector. Moreover, many of the big players need divestments to boost returns, and buyers are not willing to pay up tor most of the assets on the market — another reasons why cash returns to shareholders may be limited for 12 to 18 months…
