Over the past five years, many banks and other financial companies have transformed themselves from ...
Over the past five years, many banks and other financial companies have transformed themselves from low-tech, mature cyclicals into high-tech creators and distributors of products for the expanding global savings market. This has led to double-digit earnings growth in the UK and US.
Looking ahead, the transformation of the global financials arena has created many potential investment opportunities. In the retail banking area, the big players are gaining cost and revenue advantages by utilising new technologies, enabling them to increase the effectiveness of their marketing efforts.
The biggest opportunity of all is in the growth of the long-term savings market. Demographic changes in the developed world are forcing governments to shift from state pension provision towards persuading individuals to take greater responsibility for saving. This is particularly true in Continental Europe, where funded pension schemes are generally in their infancy. This positive outlook should also be viewed against the current economic backdrop. Following a period of exceptional economic growth, primarily led by the US, we are now seeing signs of a slowdown.
Some observers see this current environment as negative for global financials - in fact the opposite is true. The prospect of further rate cuts is good news for financials. Falling interest rates are usually a boost for banking profitability and tend to be greeted positively by the financial markets.
While a downturn in the economy will always include some debts going sour, as the cycle of economic growth slows, financials are in a more favourable position than they have been in previous periods of slowing growth. There are a number of reasons for this:In the corporate sector, the issuance of corporate bonds by companies to boost funding is now much higher than ever before, particularly in the US, and so the corporate bond market will bear the brunt of any 'credit crunch' more heavily than the banking sector. To a large extent, this potential bad news has already been factored in. Furthermore, much of the excess investment in the current cycle took the form of private equity.
Increased diversification of bank loans in previous economic downturns have exposed problems for banks, primarily because their lending was too heavily concentrated in a particular vulnerable sector. Now their loan exposure is more broadly diversified, ensuring enhanced resistance to any specific problems.
The combination of a future low interest rate environment, coupled with the massive demand for long term savings creates a positive outlook for global financials. Given the favourable position financials now have in the present economic conditions compared to the past, we can look forward to new growth opportunities.
David Jane is global financials fund manager at M&G
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