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Friday, 14th August 2020
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The trick will be to avoid the ‘value trap' Back  
Eamonn Hughes, Best Analyst Financials in the Survey, fears that despite swift price adjustments the rolling credit cycle will ‘ensure that valuations and share prices will still be far off last year’s highs.’
Many headwinds face the Irish financials in 2008, including slowing economic growth, declining house prices, the elevated cost of wholesale funding and the rising euro. We remain below consensus in both Irish GDP estimates and key stock metrics in the market to reflect these perceived risks. Whilst valuations have fallen precipitously through 2007, the question remains whether this is a ‘value trap’, given the prevailing macro backdrop, or whether many Irish financials are inherently cheap - trick or treat?

So we start 2008 with a certain sense of trepidation due to the ongoing financial market turmoil. We have analysed all the stocks on a range of fundamental factors. Our resultant investment templates highlight that Financial stocks score highly, particularly driven by the heavy share price declines in the second half of 2007, which, in many instances, has valuations at near 20-year lows. For investors with longer-term horizons, who can look through the current turmoil, our screening process indicates that these stocks are currently offering very attractive value.

However, we open 2008 in the teeth of a ‘financial storm’ and acknowledge the market’s reticence to chase cyclical or financials plays too early, until the ‘stepping stones’ of:
Greater clarity on international bank balance sheets… A better sense of the direction of interest rates… Visibility on when the housing supply will start to bottom out all fall into place.

It is very clear, however, given recent price actions, that the US and UK property sectors are becoming just as important as share price drivers of the Irish financials stocks as the domestic newsflow. As fears of recessions grow in these two economies, the debate on financials becomes one of whether rates cuts will be sufficient to stave off recession. We are firmly in the camp that we will muddle through with sub-trend GDP growth domestically, with GDP growth pencilled in at 2.3 per cent in the current year and 2.5 per cent in 2009. This will see earnings essentially flat at the banks as the credit cycle finally commences.

While it is going to be difficult to call the bottom, we recognise the potential value trap - ‘the trick’ - in chasing the banks too early and the market’s requirement to see our stepping stones in place. Our macro view is that many of these issues will be resolved through 2008, which will see the market rotate in due course towards financials/cyclicals. When it does, price adjustments will be swift - ‘the treat’. Having said that, the rolling credit cycle will ensure that valuations and share prices will still be far off last year’s highs.
The above scenario would see us starting to build up positions in AIB Group, Bank of Ireland and Irish Life & Permanent in the coming months, as the stepping stones start to fall into place, reinforcing our comfort on the medium term outlook. We would keep the focus on the larger cap stocks. The financials, building materials and other Ireland-related plays have all fallen by similar levels from their highs through 2007. When the turn comes, our belief is that they will all bounce by a similar order of magnitude.

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