* Banks to Overweight – playing with poison
9 times out of 10 when we start playing around with the Banks sector we end up regretting it. It’s a
bit like poison ivy – it starts to irritate at the first touch. So it is not without much consideration and
soul searching that we upgrade the sector. The fundamentals may not be convincing, but we cite
two motivations – portfolio construction and valuation.
* Portfolio construction – Banks look better relative than absolute
We are wholly suspicious of the rally in commodity stocks and industrial cyclicals. Compared to ytd
performance in these areas, the Banks sector looks increasingly like an outlier – no optimistic take
on prospects here. A UK ‘remain’ vote on the 23rd could provide the catalyst, and with the ECB
supporting the European credit market, domestic risk looks preferable to global. Further, with the
Fed apparently about to hike again, just maybe the worst of the yield curve flattening is done.
* Valuation – at historic extremes
The Banks now trade on a 2016E book value multiple equivalent to 41% of the market (IBES), for a
2016E ROE of 60% of market, rising to 65% in 2018E (IBES). The sector already offers a 40%
dividend premium, and medium term there is a potentially helpful debate around the sector’s costof-
equity. The operating environment is difficult and regulation a major source of uncertainty, but
unlike many parts of the market, investors are arguably incentivised to take a little risk here.
* Media – cut to Neutral
We cut Media back to Neutral to fund this upgrade to Banks. We think Telecom offers a better play
on the European consumer, while the declining cash flow appeal of Media erodes one longstanding
support for the sector. Given the cyclicality in advertising spend, the Agencies look
exposed to downside risk given fading momentum in lead indicators, such as the Global PMI.