The latest reason not to buy into the banking sector

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.

• Stay up to date with MoneyWeek: Follow us on TwitterFacebook and Google+

FREE daily investment email from MoneyWeek
Receive our thought-provoking investment email Money Morning every weekday morning, plus occasional promotions, & become a smarter investor.

Please enter a valid email address

To sign up, enter your email address:

  • quark

    Looks like a contrarian investment to me.

  • Boris MacDonut

    Banks are a lot like Russia. No trust internally or externally and where there is no trust do not invest.

  • Atters

    The article misses the tremendous earning power banks have. Any increase in costs will simply be passed on to consumers. The interest rate differential that banks are enjoying at present to enable them to repair their balance sheets has never been greater. Write backs will also start appearing. Not a bad bet.

MoneyWeek magazine

Latest issue:

Magazine cover
Party's over for Putin

The only portfolio safe from Russia's rout

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues

Hedge fund manager Hugh Hendry: 'It felt like the sun rose only to humiliate me'

In a series of three short videos, Merryn Somerset-Webb talks to Hugh Hendry, manager of the Eclectica hedge fund, about everything from China to the US, Europe, and Japan.


Which investment platform?

When it comes to buying shares and funds, there are several investment platforms and brokers to choose from. They all offer various fee structures to suit individual investing habits.
Find out which one is best for you.


19 December 1932: BBC World Service begins

The first royal Christmas message by George V gave the fledgling World Service an early boost six days after it was founded in 1932.