Why Now Could Be Timely To Ditch Shares In Lloyds Banking Group PLC And Barclays PLC

On Wednesday 29th April we expect an interim management Statement from Barclays (LSE: BARC), and on Friday 1st May we expect one from Lloyds Banking Group (LSE: LLOY).

What will they say?

The news from both firms should be good. Since their post-recession profit lows, Lloyds and Barclays fought back and now seem on course to either match or beat their peak-profit scores at the end of the last macro-economic cycle.

Back in 2007, Lloyds earned £4,000 million before tax and Barclays £7,076 million. By 2011 Lloyds was posting a pre-tax loss of £3,542 million and, during 2012, Barclays earnings were down to £797 million.

Lloyds’ takeover of HBOS skews the figures but, allowing for that, we can see that the two banks are roughly back to where they were on profits in 2007. Indeed, City analysts forecast pre-tax earnings of £8,043 million for Lloyds and £8,359 million for Barclays during 2016.

The recovery for these banks already happened and the shares price it in. At today’s 79p Lloyds’ forward P/E ratio for 2016 sits at about 9.8, and at 263p Barclays’ is running at around nine. We shouldn’t expect a higher rating for these ultra-cyclical businesses. In fact, we should expect these multiples to gradually contract as the macro-cycle matures.

If recovery is over, what about growth?

Racy, double-digit earnings growth seems unlikely to continue over the next few years. Much of what we’ve seen on fast-paced rises in earnings over recent times was cyclical recovery, but that’s now finished, arguably. Business expansion must drive growth now. How likely is that?

Not very likely at all, according to those other bankers HSBC Holdings. In the recent AGM statement, the firm points out the banking industry suffered close to US$200 billion of litigation costs over the last few years, thanks to errant behaviour. Naturally, there was an up swell of public opinion bent on hammering the banks back in line, and that caused repositioning of the entire industry, driven by regulatory and structural reforms. In the UK, such reforms include the requirement to ring-fence core UK financial services and activities within a bank’s wider operations.

Regulatory pressures like that raise the costs and complexities of trading in Britain, as does the very real possibility that the UK might leave the EU and then continue on its path to oblivion by breaking itself up into its constituent parts. That’s why HSBC is considering relocating its head quarters outside the UK and flogging off its entire UK banking operation — a vote of no confidence in a market if ever I saw one!  

The big problem for Lloyds Banking Group and Barclays is that they’ve been shrinking their big-earning, and sometimes big-losing, international trading lines to concentrate on traditional forms of banking in the home market. The timing is unfortunate, but the necessity ushered in by their own hands. What it all nets-out too is lots of UK-facing banks all scrabbling over a diminishing pie.

What about cyclicality?

Growth seems set to remain lacklustre, and competition fierce, for the remaining positive undulation of this macro-economic cycle. As we weave onwards through it, the next big move that threatens to appear is the down-leg. Nobody knows when it will arrive, but a downturn in the economy is never good for a bankers’ share price.

Meanwhile, the stock market, which grasped the measure of cyclicality long ago, seems set to compress bank valuations steadily in anticipation of that next economic plunge. Valuation-compression like that is bound to drag on total returns from here for investors in the London-listed banks.

Right now could, indeed, be timely to ditch shares in the likes of Lloyds Banking Group and Barclays. Instead, look at these 'real' businesses with strong trading franchises that look set to keep their ends up through the ups and downs of macro-cycles. You can find out why we love these firms so much for FREE by clicking here.

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.