These are strange days to be investing in banking stocks, which still haven't recovered from the seismic shock delivered by the financial crisis. Currently, they are going through one of their periodic bouts of popularity, but can it last?
Banks bounce back
Just take a look at Barclays(LSE: BARC) and HSBC Holdings(LSE: HSBA). These bad boys have been living it large over the last six months, rebounding a spectacular 50% and 35% respectively, and investors will be hoping for more fun to come.
So why all the excitement? It's partly due to a revival in animal spirits, as initial Brexit fears recede, and markets rightly or wrongly decide that President Trump might do them a favour or two. Inflation's long-awaited comeback is also spurring them on, as the banking sector will find it easier to boost net lending margins when interest rates finally do start rising.
Banking stocks picked up when the benchmark 10-year UK gilt climbed to 1.35% on 9 January, after December's positive PMI survey data was published. Today, gilt yields stand at 1.45%. If the US Federal Reserve hikes rates again in March, UK banks could be one of the many knock-on beneficiaries.
Barclays chairman John MacFarlane has backed London, despite Brexit, saying that the City had a "competitive advantage" over its rivals, and that his bank is increasingly focused on the UK and US. It seems likely to use Dublin as its post-Brexit contingency base. HSBC boss Stuart Gulliver has suggested it may transfer around 1,000 staff to its Paris office if EU passporting rights are lost. Neither statement suggests too much concern about Brexit fallout. The banks are canny enough to survive.
Deutsche Bank recently upgraded Barclays to a 'buy' from 'hold', lifting its price target to 270p from 198p, saying that after a year of restructuring and transition to a new reporting structure, it is well placed for earnings growth. HSBC has also undergone major restructuring and remains heavily dependent on China, where economic growth continues to slow, while local credit and property bubbles continue to inflate. The bank's long-term strategy seems spot-on, but could hit short-term volatility.
Inevitably, recent strong share price growth has made both stocks more expensive. Barclays now trades at 13.5 times earnings, and HSBC at 13.1 times. Barclays' price-to-book ratio is a lowly 0.6, which suggests an element of undervaluation, while HSBC slightly less so at 0.9. Their dividend yields have also fallen, with Barclays currently offering income of 2.9%. HSBC offers an attractive 5%, although this is rather less eye-catching than the 7%+ yields recently on offer.
I feel there could be further excitement to come. Barclays' earnings per share (EPS) are forecast to rise a thumping 51% this calendar year, and another 15% in 2018 (this follows two negative years). HSBC is set to turn around three negative years with EPS forecast to rise 6% in 2017 and 7% in 2018.
Naturally, Barclays and HSBC both are at the mercy of swings in capital markets, the wider economy and, increasingly, politics -- consider, for example, the effect if President Trump triggers a wider retreat from globalisation. As ever, investors should brace for short-term volatility, but the longer-term outlook looks increasingly positive for both banks.
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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has recommended Barclays and HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.