Research Portal

Banks “23/8 is 9/12-light – for now”

/
inghams_pic01-1.jpg

Recommendation

I’d advise caution on exposure to interest rate sensitive stocks for the time being.

SA_flag.jpg

Banks are particularly sensitive to fluctuations in long bond yields, the primary driver of the value of the big four banks.

As the graph below illustrates, the share price of Barclays Group Africa has an inverse relationship to the ten year government bond yield. 

Share price is the inverse of the bond yield

Share_price_is_the_inverse_of_the_bond_yield.jpg

On the basis of my modelling, a 55 basis point increase in the ten-year government bond to 9%, which is what we have seen, reduces the present value of future earnings by 7,2% and thus the value of the share.

If the bond yield had to drop by 55 basis points then all else equal the value rises by 8,2% and if the yield fell by 110 basis points then the value rises by 17,6%.

However, if we have a repeat of Nenegate (let’s call it Pravingate) and we see yields spike by 200 basis points, which is what happened on Thursday, 10 December 2015, then the present value of earnings falls by 22,5% from the base case. In an environment of contagion, the negative impact is likely to be greater than in a static modelling scenario.

Bank share prices are already off 5% to 7% over the past few days and in the prevailing uncertainty prone to further weakness.     

Valuing banks in the current context

The risk-dampening triumph that was the outcome of the municipal elections came to an abrupt upending on the evening of Tuesday, 23 August.

elections.jpg

After a municipal election, that I described on 8 August as South Africa’s Brexit moment, there was a fortnight of respite from otherwise disturbing political trends. There was a re-emergence of confidence, manifest in bond markets and the currency.

The significance of the municipal elections process and outcome should not be underestimated but meanwhile underhand party-political forces overshadow this positivity to reignite investment hazards.     

Political machination is the only possible cause behind an insidious ploy to besmirch a world-class finance minister through an accusation that is spurious in law and a travesty of due legal process.

Rotten politics makes for rotten governance if practiced through a kleptocractic cronyism indifferent to consequence. This nevertheless has immediate financial consequence through adverse market price signals, which in turn has real economic impacts.

South Africa is fortunate to have deep, liquid and sophisticated financial markets. Markets reward and markets punish. If a government cannot impose self-discipline and prudential management, markets bludgeon it in to doing so the hard way.

The twin forces of democratic accountability and free markets are an effective coercive counterweight to misrule.

Since last week, the 10 year R186 has risen by 55 basis points to 9%, the rand has lost 7% against the US dollar and the JSE banks index is 6% lower. Standard Bank, Barclays Group Africa and FirstRand are down 7% with Nedbank off 5%. Insurers such as Sanlam and Discovery are also softer.    

Share prices of Barclays Group Africa, FirstRand, Nedbank and Standard based to 100

Share_prices_of_Barclays_Group_Africa_FirstRand_Nedbank_and_Standard_based_to_100.jpg

This is a small market movement relative to the rout following 9/12 or Nenegate. If there is a repeat of 9/12 in the near future all bets on the downside are off.