Goldman Sachs red-flags expensive financials

Banking stocks have appreciated 35% in six months; liquidity may continue to drive up some of these stocks but a re-rating is unlikely

Goldman Sachs has waved a red flag to runaway valuations of financial stocks, especially those of select banks. The brokerage’s January 30 report likely explains the recent sell-off in banking stocks. It says a macro revival will not only drive liquidity but re-rating as well.

On January 14, the brokerage downgraded six stocks to ‘neutral’ or ‘sell’, and the European Central Bank announced its euro 1.1-trillion bond-purchase programme soon after. While the liquidity driven by the latest programme will test any negative stance on financial stocks, Goldman Sachs is of the opinion that there are near-term risks to earnings of banks and other financial companies.

 

Justifying its stance on the sector, Goldman Sachs’ Tabassum Inamdar writes in the January 30 note: “We recently turned more cautious on financials, after significant valuation re-ratings. While our macro team remains long-term positive on the Indian macro environment, we acknowledge the near- to medium-term risk to earnings from slower reforms and their impact on the investment cycle.”

Banking stocks have appreciated 35 per cent in the past six months. While liquidity might continue to drive up some of these stocks, a re-rating is unlikely as earnings are not expected to pick up anytime soon. The long-term outlook on the Indian economy is robust but the brokerage is recommending lightening positions, as valuations have run ahead of fundamentals. Additionally, the brokerage has downgraded two popular stocks — YES Bank and IndusInd Bank — in its note.

Even as liquidity is driving up bank stocks, credit growth continues to remain tepid. It can pick up only when the investment cycle revives and leads to improved profitability of banks. FII flows into Indian equities have driven the benchmark indices — more so the financials, which are a proxy for the broader economy. Since November 2008, the Nifty has risen 206 per cent, while the Bank Nifty is up 343 per cent. Within the banking stocks, private banks have zoomed 490 per cent during this period, while state-run banks have risen 216 per cent.

Be it from an earnings perspective or valuations, Goldman Sachs believes state-run banks are trading at low valuations, and private ones at their peak valuations of 2011. Goldman Sachs has retained a ‘buy’ rating on State Bank of India, Bank of Baroda and Oriental Bank of Commerce.

In the past, re-rating of bank stocks have been driven both by liquidity and regular rate cuts. But this time, the rate cut cycle is expected to be much shallower than the previous one, in 2008. As a result, the impact of liquidity infusion might be limited, as the requisite support from a monetary-easing cycle will not happen.

A rate cut of 50-75 basis points might take place over a 12-month period, as oil prices and normalisation in the US Federal Reserve’s monetary policy are some unknowns the Reserve Bank would factor in.