Picking one share to buy when there are thousands to choose from is never going to be easy. That’s the case even in a stock market which has risen significantly in recent years and where the margins of safety now on offer seem narrower than they once were.
However, the banking industry appears to be one sector that is undervalued at the moment. This could be due to investor sentiment remaining weak after the financial crisis, or simply a lack of consideration for the investment potential the sector offers. Either way, one of the UK’s biggest banks, Lloyds (LSE: LLOY), could be a strong performer in the long run.
A changing world
While the last decade has seen interest rates fall and then remain at rock-bottom levels, the reality is that change is ahead. This has already started to some extent in the UK, where interest rates have risen since reaching an all-time low. However, a further tightening of monetary policy could be ahead due in part to the impact of Brexit.
Since the EU referendum, the pound has generally weakened. Although it has seen some support in recent months, it could weaken in future as Brexit draws closer. This could have a positive impact on the UK economy, since exporters may find they are more competitive versus their international peers. This may mean there’s less requirement for such a low interest rate and a more hawkish monetary policy could follow.
At the same time, a weaker pound could lead to higher levels of inflation. Already, the rate has hit 3%, and it could move higher if uncertainty surrounding Brexit builds in the coming months. This may mean that a higher interest rate is required in order to try and cool the growth in the price level.
Improving trading conditions
A higher interest rate would be good news for Lloyds and its banking sector peers. It would mean there would be increased scope for a higher net interest margin. This is simply the difference between the interest rate a bank charges to lenders and the one it pays to savers.
In recent years, there has been little opportunity for increased profitability across the banking sector, due in part to low interest rates. But with the UK set to enter a new era which includes a potentially more hawkish stance on monetary policy, the profitability of the banking sector may be set to improve.
This could translate into higher share prices for Lloyds and its peers. After a decade in which a sustained recovery has still not yet taken hold, buying the stock now could prove to be a shrewd move. Its dominant position in the UK may mean it benefits the most from a rising interest rate over the coming years. As such, its shares could deliver the highest gains within what may prove to be a growth sector.
