Lloyds (LON:LLOY) and Barclays (LON:BARC) have bounced back extremely strongly from the 2020 stock market crash. The FTSE 100-listed banks are trading 70% and 110% higher, respectively, versus their lowest point in April 2020. In comparison, the index is currently 35% higher over a similar period.
The two banks continue to trade at cheap prices despite their recent gains. With an improving economic outlook and growing dividends potentially ahead, could they offer further FTSE 100 outperformance?
An economic transformation
Despite this, the IMF forecasts that the UK economy will grow by over 5% in 2021 and in 2022. This suggests that the operating outlook for Lloyds and Barclays could dramatically improve over the coming months. A fast-growing economy may mean lower default rates, lower impairments and higher demand for credit. It could even strengthen calls for higher interest rates.
Of course, UK monetary policy is not due to substantially change until 2024 at the earliest. However, investor anticipation of a return to tighter monetary policy may act as a positive influence on share prices in the banking sector. Meanwhile, their profits could increase over the long term in an era where rising interest rates are used to counter higher inflation.
Both banks delivered encouraging results in the first quarter of the 2021 calendar year. Lloyds reduced operating costs by 2% because of its disciplined cost control. It also increased its common equity tier 1 (CET1) ratio by 0.54 percentage points. It now stands at 16.7%, which is significantly higher than the regulatory requirement of 11%, and suggests that it has a relatively sound financial position.
Subscribe for more stories like this, 8am weekdays - for free!
Meanwhile, Barclays delivered a record quarterly group profit before tax in the first quarter of 2021. The bank was aided by its international exposure, with Corporate and Investment Bank (CIB) income remaining robust despite uncertain operating conditions. Although its cost/income ratio increased to 61% from 52% in the comparable quarter from 2020, it continues to target a figure below 60% over the medium term.
Share price prospects
Dividend payments made by both banks are set to rise as the economy’s performance improves. Currently, dividend yields are expected to be 6.5% for Lloyds, and 5.3% for Barclays, in 2022. This could make them increasingly appealing in what may prove to be a prolonged era of low interest rates.
Clearly, such a situation is unlikely to be beneficial for the banking sector’s profitability in the short run. But with low valuations, improving financial prospects and a likely economic recovery that may spawn hawkish tones from the Bank of England, Lloyds and Barclays may offer further outperformance of the FTSE 100 over the long run.
This article was first published on Master Investor on 24th June 2021.