A couple of years ago, I noted that not everything reverts to its mean. I pointed particularly to the price of shares in the UK banking sector. Go back to 2012 and look at them in terms of ther historical price/earnings (p/e) ratios or their price to book ratios and they looked more than cheap – they looked practically free.
But I still couldn’t bring myself to buy them. As I said at the time, the banking business model of the past couple of decades (taking advantage of leverage, abnormally low interest rates, and light-touch regulation to make managers rich and shareholders poor) is not a model that will be allowed in the next decade.
I expected significantly tougher regulation to come in at some point, alongside “intense public scrutiny” as well as a range of new entrants to markets that had long been monopolised by our big big banks – think peer-to-peer (P2P).
I also thought that in the longer term, we would see changes to managerial incentives that would drive lower short-term returns in future, and see valuations stick far below their old mean.
I’m still waiting for a lot of this, but the intense public and regulator scrutiny is definitely with us, something that Neil Woodford (now mainly known as ‘superstar fund manager Neil Woodford’) appears to have noticed too.
He is known for his long-term value approach to investing, but has just sold out of a stake in HSBC bought only a few months ago. Why? “Fine inflation.”
As the demand from the public to see the banks suffer in one way or another has grown, so has the absolute level of the fines that the regulatory authorities have been imposing for “past and ongoing wrongdoings”.
You can read superstar fund manager Neil Woodford’s views on the matter, but “in the light of this growing risk” (note the Bank of America has just agreed to pay the “largest single federal settlement in the history of corporate America”), he now considers HSBC shares to be “broadly fair value”, and therefore not worthy of inclusion in his portfolio.
It makes sense to us – we will be adding ‘fine inflation’ next to ‘increased scrutiny’ and ‘regulation’ in our very long list of reasons not to fall for the idea that low-looking valuations justify buying shares in banks.