Last year, the banking sector was the standout for share price gains in the FTSE 100. Major companies including NatWest Group (LSE:NWG) and Barclays (LSE:BARC) almost doubled in value.
Yet despite this surge, I’m a little more conservative when it comes to the outlook for the year ahead in this area. Here’s why.
Valuations
Don’t get me wrong, I don’t think banking stocks are overvalued in general. Yet the reason to buy them as undervalued picks has now disappeared.
For example, the Barclays price-to-earnings ratio has doubled over the past year, with it now just below 10. I use 10 as a benchmark for a fair value for this ratio. So the fact that most of the FTSE 100 banks are now priced fairly leads me to conclude that sharp share price increases in 2025 are more unlikely.
As the below chart shows, both NatWest and Barclays shares are at their highest level in five years. Over the past year, Barclays jumped 72%, with NatWest up 82%. Although this fact alone doesn’t mean the stocks are overvalued, psychologically it could put off some new investors. It’s harder to convince someone to buy a stock at multi-year highs, as they have the human emotion of wanting to get a bargain.
Interest rates
A change in the base interest rate has a large impact on profitability for banks. Last year, interest rates in the UK and US stayed higher than many people expected. This was a key reason why the banking sector did so well. Both NatWest and Barclays have large retail banking operations. This means they pay out interest on deposits but can lend out money via mortgages and other loans. The difference in the rate is the net interest margin for the bank.
However in 2025, the UK, US and other nations could cut interest rates more aggressively. This would be the case if inflation doesn’t spike higher in coming months. In this scenario, net interest income should fall. This would likely have a knock-on impact on the respective stock prices.
Individual problems
Several banks are dealing with specific issues which could provide a distraction this year. For Barclays, it lost a legal case in December relating to the potential mis-selling of car finance. There are other ongoing cases, but the potential reputational damage and compensation payments could be large.
For NatWest, it’s the change at the top, following the resignation of Alison Rose amid a political scandal in 2023. Paul Thwaite has taken the helm, but investors will be watching things closely to see how any strategy changes play out in his first couple of years.
Of course, I could be wrong with my viewpoint on the banking sector. Further, just because I don’t think the roaring returns of 2024 will be matched, it doesn’t mean I think the stocks will massively fall. I just feel other sectors offer investors better opportunities as we start the year.
This post was originally published on Motley Fool
