Banking on beliefs

In their book, The Enigma of Reason, Hugo Mercier and Dan Sperber write: “Two major features of the production of reasons: it is biased – people overwhelmingly find reasons that support their previous beliefs; and it is lazy – people do not carefully scrutinize their own reasons. 

Combined, these two traits spell disaster for the lone reasoner. As she reasons, she finds more and more arguments for her views, most of them judged to be good enough. These reasons increase her confidence and lead her to extreme positions.” 

In short, it basically means that our ability to argue is limited to our own beliefs. Mercier and Sperber were referring to beliefs such as the belief that a bull becomes infuriated by the colour red, or that ostriches bury their heads in the sand at the first sign of impending danger. 

But the actual truth is that bulls are dichromats, which is a fancy term for a living organism for whom the colour red doesn’t really stand out as bright in any way; while ostriches, well, we all know don’t really bury their heads in the sand. 

For some reason, however, we seem to believe that they do. A belief that I must deal with on a regular basis is the belief that local banks have completely lost their sparkle in recent years, mainly due to the South African macro-economic environment, and the country’s political environment.

Make no mistake, I’m not burying my head in the sand by arguing that these factors didn’t play a role, but what really makes me see red is the belief that negativity in the banking sector started locally, and this is being exploited by “SA bears” as one of the main reasons why South Africans should seek salvation offshore. 

The main reason for this poor performance shouldn’t be searched for locally but should rather be investigated as part of an international trend. 

When we take a look at the MSCI World Banks Index, which consists of all listed banks in 23 developed countries, you will see that no different to SA banks since early 2018, they underperformed sharply against the MSCI World Index (i.e. all shares) – to such an extent that international investment companies already highlighted this underperformance as a possible overreaction and an investment opportunity for value seekers.

You will see that there was a significant increase in pressure on world banks following the start of the US’ increase of the Federal Reserve’s (Fed’s) interest rate, which also placed pressure on the sector in general. 

There was also a slight improvement in mid-2019 when the Fed rate was lowered, but that was short-lived. International investors clearly feel that these rates won’t stay low for much longer, which in turn will have a negative effect on US banks (which makes up 46% of the MSCI World Banks Index).  

When we look at local bank shares (FTSE/JSE SA Bank Index) and place them relative to the FTSE/JSE All Share Index, it becomes clear that the picture has looked similar since the beginning of 2018. 

The big difference is that the local repo rate is now trading lower than at the beginning of 2018, which makes the fact that we are being swept along by these international tides somewhat unfair. 

At this point, I just want to reiterate the fact that I am aware of the reasons why we have been suffering on both a local economic and investment level. From an investment opportunity perspective, however, the figures are starting to look very interesting. 

Capitec has continued to be a fantastic case these last two decades, so we will be excluding it from this illustration. Let’s look at a few key indicators on the remaining four large banks in SA, namely Absa, FirstRand, Nedbank and Standard Bank.

The growth rate of banks is slightly lower than the five-year average, which is a clear indicator of the difficult environment (discussed earlier) we find ourselves in.

Both the price-to-earnings ratio and price-to-book ratio are trading lower than their five-year averages, and at a dividend yield of 6.4%, I’m starting to wonder whether we should invest in our local banks rather than just save our money in them. 

There is still a lot of uncertainty surrounding us and we are definitely finding ourselves in high-risk territory.

But given the choice to buy shares that are trading at historically higher levels versus those that are trading at historically lower levels during high-risk periods, I would without a doubt choose the latter.

Schalk Louw is a portfolio manager at PSG Wealth.

This article originally appeared in the 5 March edition of finweek. Buy and download the magazine here or subscribe to our newsletter here.