In this article, Kokkie Kooyman explains why we believe that warmer investment weather is on its way. Seasonal changes always take place in investment markets and Kokkie explains why ‘summer’ may well be on the horizon. While we don’t typically forecast the seasons, there are some fundamental changes to be aware of, not least the potential Covid-19 vaccine. This will be a game changer for numerous reasons and the financial sector will be one of the biggest beneficiaries of a positive and gradual increase in GDP growth off a low base.
Just like the weather, investment seasons change.
When I was a young boy, we had a Dutch barometer hanging on the wall in our house. It was in the shape of a house with two entrances. When good weather was on its way, a lady dressed in summer clothes would emerge from one entrance. When poor weather was on its way, a man with a raincoat and umbrella would appear out of the other entrance. Sometimes the barometer would indicate ‘veranderlik’ (Dutch for ‘variable or changing’) and both the lady and the man would hover in their doorways.
After a heavy winter there was always plenty of excitement in our home when the forecaster finally started indicating ‘mooi weer op komst’ (Dutch for ‘warmer weather on its way’); because in the Netherlands it often rains or is overcast for months on end.
Figure 1: An example of an old Dutch barometer
The market’s financial sector barometer that has stood on ’variable’ for quite a while, has finally changed to ’warmer weather on its way’.
While this is a forecast, a few things have happened that increase the likelihood that better investment weather is on its way − the most significant of which is the recent headway that has been made towards having a Covid-19 vaccine. A vaccine means increased travel, a boost to tourism, more shopping and, among other things, spectators being allowed to attend sports events again. This increase in activity will cause an immediate uplift to global GDP growth, lower unemployment, increased tax revenue for governments and reduce the need for stimulus packages.
1. If this forecast is correct, the financial sector can expect increased demand for its products, especially demand for credit (working capital) at gradually higher interest rates (higher volume at improved margins). Thanks also to increased Covid-19-induced digitalisation, this will be on a gradually lower cost base.
2. It would mean that the provisions for bad debts that were built up will not be needed and some of this could even be released. It certainly means that the charges for bad debt in income statements will be considerably lower in 2021 resulting in potential increases in earnings growth in excess of 50%.
3. But even before we see the Q1 and Q2 2021 earnings releases, regulators will change their stance on dividend payments (we should see them normalise) and allow share buybacks.
It is beneficial to anticipate the change in season.
The market knew the probability of a vaccine being found was very likely but preferred to err on the side of caution until there was more certainty and a better idea of timing. Similarly, regulators will allow banks and insurers to resume dividend payments and buybacks again but many investors seem to want to wait until this is being announced. However, it is far more beneficial for investors to anticipate events and already be invested when the good news is announced, especially when the odds in terms of valuation and earnings growth are in their favour.
The odds are in investors’ favour.
In RMB Morgan Stanley’s 2 October 2020 ‘Charts that made the difference this week’, Ian Doyle (who’s been around almost as long as I have), used the figure below to highlight how the US financial sector has been sold down relative to the S&P 500 Index, while earnings have only dipped marginally. The chart shows how much catching up there is to be done, and the previous occasions when the financial sector had been sold down and earnings turned positive.
Figure 2: There is a lot of catching up to do when we compare previous periods when earnings turned positive.
Source: RMB Morgan Stanley, Charts that made the difference this week, 2 October 2020
We’ve held three virtual client presentations since March 2020, where we argued that the weather would change in 2021.
The vaccine increases this probability. If our forecast turns out to be correct (based on our research of previous recessions and interactions with management teams) then there is still considerable upside. It isn’t as much as earlier this year, but there is enough to keep attracting buyers back to the sector for quite a while. The forward dividend yields are very attractive. Most importantly, the financial sector is one of the biggest beneficiaries of sunny weather and for the next few years will benefit from the gradually increasing GDP growth off a low base.
If you believe that the weather is changing, perhaps it’s time to pack away your raincoats and buy summer clothes?
We’re hosting a webinar next week on the global financial sector. If you’d like to join, please register using the link below.
Date: Tuesday, 24 November 2020
Time: 14h00 – 15h00
To register for this webinar, please click here.
Ian Kirk will be joining our webinar as a special guest. Ian was previously Sanlam Group CEO (2015 − 2020), Santam CEO (2007 – 2014) and Deputy CEO of Liberty Group (2005 – 2006). He is currently a board member of JSE and Transaction Capital and a member of the Presidential State-owned Enterprise Council, mandated to reposition South Africa’s state-owned enterprises. He has considerable experience in the financial sector and has been in charge of a number of very successful companies. He’ll share his views on the future of the financial sector in a more digitalised post-Covid-19 world.
If you would like to listen to our previous client presentations, please click on the links below:
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