As UK stocks refuse to collapse, some Remain supporters highlight the drop in bank shares as evidence of the self-inflicted wounds of the referendum. A quick look at OTAS shows that the reality is different.
Earnings expectations for RBS, in blue above, have fallen 7% in the past week, but have also reduced steadily since November 2014. The rate of decline accelerated from November 2015 and the recent drop is not the steepest downgrade of the past year. What did happen, however, was that the stock price diverged from trend earnings from early May and it is the reversal of this move causing the recent, sharp fall in the share price.
There was no reason based on the likely result of the referendum for the RBS share price to rally while its earnings fell. At the very best the status quo was on offer, which suggests that there was a degree of irrational exuberance ahead of the vote. Equally, if the share price was to fall far below the trend of earnings, this would imply that the EU was a source of strong growth for RBS, which we have not heard even the heartiest Remainer claim.
The situation is very similar for Barclays, although the negative EPS Momentum and share price moves are not as marked. To put the referendum reaction in context, the long-term chart of Barclays’ share price and 12 months’ forward earnings expectations is shown below. NAD refers to New Annual Data and marks the date of publication of the annual accounts.
Earnings expectations for Barclays have fallen sharply from the beginning of the year and it is hard to discern any meaningful Brexit impact. Over the long-term the share price tracks earnings momentum rather well. (If you want to know the discount for government ownership of a bank, check out the same chart for RBS using OTAS.)
Uncertainty is the bug-bear of market participants and implied volatility for UK banks has jumped to exceptional levels, on a two-year view. The uncertainty is a result of the referendum vote, but one read of the Bank of England’s Financial Stability Report is that Brexit has exposed significant fault lines through the UK economy that were already there. Further interest rate cuts and monetary measures to suppress volatility are the only game in town as far as the Bank is concerned, but this will continue to damage commercial banks’ earnings prospects as has been the case for many months.
One unknown for UK banking is whether non-EU banks will retain passport rights to operate on the mainland. If not, then some very senior US bankers will be looking for a new home on the continent, which is not a prospect that particularly appeals. Expect passporting to be the post referendum hot topic, much to the bemusement of the majority of voters.
Goldman Sachs has an important passport bank that is currently based in the UK. This, however, is not the primary determinant of the group’s earnings outlook. The chart below shows that exuberance for Goldman Sachs shares occurred about a month before the rally in UK banks, but that share price and EPS estimates were converging from early May. Once again, earnings momentum is the best indicator of long-term share price.
Brexit is a great excuse for managements who need to impart bad news about earnings. Banks in particular sense rare media support for their plight, even though earnings have been falling for months and share prices were out-of-kilter with forecasts before the referendum. Whether Brexit, or over-leverage and a clampdown on tax inversion has slain the M&A golden goose, the best game in town for investment banks has ended. Throw into the mix that senior bankers may be leaving London and you have a number of upset people.
We are not singling out Goldman Sachs, other than in our title, which will most likely be one of the industry winners whatever the outcome. For all passport banks there is talk that Paris is not a likely destination because of the Establishment’s dim view of banking, Frankfurt a little dull and Dublin lacking infrastructure. All of a sudden Madrid emerges as one of the most liveable EU cities for jet-set financiers. There remain only the minor issues of where to buy a latte prior to market open and getting an answer for the East Coast before tomorrow.