Dovish Carney fails to dent enthusiasm for UK banks

Despite Brexit uncertainty and a more dovish tone from the Bank of England (BoE), many managers are arguing that now is the time to embrace the big four UK banks as a cheap, tactical value play.

Dovish Carney fails to dent enthusiasm for UK banks

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Neil Woodford and Richard Buxton have talked up the attractive value opportunities in domestic banks increasingly since the EU referendum as part of a wider contrarian outlook on the UK economy.

Stephen Message, who recently took over the L&G UK Equity Income fund, has been upping his Lloyds and Barclays positions in the portfolio.

Message says the stocks have “good potential for dividend growth”.

UK All Companies funds with high allocation to banks

Fund Allocation
Schroder – Responsible Value UK Equity 22.6%
Franklin – UK Managers’ Focus 19.6%
Crux UK 16.7%
Majedie – UK Equity 11.6%
RWC – UK Focus 11%
Source: FE Analytics

“It is now a decade on from the financial crisis where a key priority for banks has been to increase capital levels to withstand any future shocks,” says Message.

“With capital levels rebuilt and risks over fines for misconduct gradually receding, combined with a rising interest rate environment, this should pave the way for an increased focus on dividends.”

Jamie Clark, co-manager of Liontrust’s Macro Process, is “heavily geared” toward value and financials on the basis that “rates will rise more rapidly than the market anticipates”.

HSBC is the fourth largest holding in Clark’s £246m Liontrust Macro Equity Income fund, which he manages with Stephen Bailey, making up 5.5% of the portfolio. In February, he and Bailey also began building a smaller position in Lloyds, which is now between 1.8% and 1.9%.

“We think that rates have inflected, that both markets and policy rates are heading higher,” he says. “We don’t think rates will mean revert to the levels you saw over the last 40 to 50 years, but we do think there is ample scope for them to do better.”

UK Equity funds with high allocation to banks

Fund Allocation
Artemis – Income 9%
Miton Income 8.4%
Janus Henderson – UK Equity Income & Growth 8.1%
Trojan Income 6%
Majedie – UK Income 6%
Source: FE Analytics

Cautious Carney

Mark Carney’s comments last Friday that a May rate rise could be pushed back don’t seem to have perturbed investors in the sector.

“It’s going to be a glacial move higher in rates compared to what we have seen historically, but I think it is likely to be quicker than the market expects,” says Clark.

He adds Carney was at pains to stress that if it doesn’t happen at this meeting, it could happen at the next.

Jordan Sriharan, head of collectives research and senior portfolio manager at Thomas Miller Investment, says the fates of the UK’s biggest banks will be driven by earnings and profitability over the short to medium-term, which itself will depend on what is going on with the domestic economy.

As such, delaying one or two rate rises will not send an overly negative message to markets that UK banks seem less profitable than they did one or two years ago.

“The BoE has taken away the funding for lending because they believe the broad domestic economy and the wider demand for credit is improved,” he told Portfolio Adviser.

“Bank profitability will be driven more now by what’s going on in the domestic and, to some extent, the global economy. I’d like to think that is a more important driver than a rate rise being put on the back burner.”

Intangible Brexit

But Sriharan points out Brexit complicates the outlook for the domestic economy.

“It’s funny, it’s almost as if your review on the domestic economy is like asking, ‘Are you a Remainer or are you a Brexiteer?’ It can cloud judgement almost.

“When we look back over two years, it’s clear the UK economy didn’t suffer a material hit to consumer spending, to consumer confidence to lending to loan growth. Where the UK economy has suffered is a fall in business investment and that is perhaps a bit more intangible.”

The domestic economy, including UK banks, could run into problems over the longer term.

“An economy is a little bit like a company where someone leaves the business,” he continues. “In the very short-term, there’s enough elasticity in a business to maintain that person’s job who has left. You can just about group together as a business and cover that person.

“It’s like this with the Brexit scenario. There’s enough flexibility in the economy to manage that gap for the next six to 12 months. It’s only in the longer term that they begin to suffer and people have to work extra to cover that person.”

Sriharan therefore has exposure to HSBC, which he sees as more global. The difficulty for RBS, Barclays and Lloyds, “is the transparency over some of the regulatory costs that are coming through,” he says.

“It seems to me there is quite a binary outcome to the UK high street bank story. We’re more cautious rather than using them as an outright value play.”