Earnings growth forecasts for 2010, 2011 are one of the highest in emerging markets.

• Deanne Gordon, Strategist at JP Morgan Cazenove, notes that SA bank shares have significantly outperformed not only other emerging market banks, but also the overall MSCI Emerging Market Index so far in 2010.

• Many investors are worried that our banks have run too hard and too far (too fast) because their PE ratios are looking stretched relative to the averages of the past.

• JP Morgan disagree with this and continue to recommend an overweight holding in SA banks for six reasons: 1) Sustained low interest rates in SA through 2010 versus a tightening in many other emerging markets 2) Recovery in loan growth 3) Unwinding of bad debts 4) Strongest expected earnings rebound (from SA companies) in 2010/11 compared with other emerging markets 5) Attractive relative valuations and 6) SA banks are under-owned.

• JP Morgan estimate that SA banks had total impairment charges (bad debts) of around R35bn in 2009 and that this will decline to around R30bn in 2010. For example, Standard Bank's impairment charges were R12bn in 2009 and are estimated to decline to R9bn for 2010. This should help bank earnings jump 30% in 2010 and a further 26% in 2011 (-24% in 2009).

• SA company earnings growth forecasts for 2010 and 2011 are one of the highest in the emerging market universe.

• JP Morgan Cazenove note that SA as a whole and SA banks too look cheap relative to other emerging markets.

• In particular, they prefer the price-to-book ratio for SA banks, saying that this valuation metric is more meaningful at this stage of the cycle than PE ratios. Price-to-book is the share price divided by the net asset value of the company (as reflected in its accounts/balance sheet). Essentially it is assets minus liabilities.

• Currently the price-to-book for SA banks is a "very attractive" 1.8 (back at 2004 levels), cheaper than the 15 year average of 2.4. By comparison, Brazilian bank price-to-book ratios are 3-plus.

• Interestingly, according to JP Morgan Cazenove's analysis of domestic fund managers' equity positions, SA banks are one of the biggest underweight sectors.

"Given that the SA bank sector is the biggest domestic cyclical sector to play an unwinding of bad debts and a sustained low interest rate environment (12.4% weighting in the SWIX (shareholders weighted) index versus just 4% for General Retailers), we (JP Morgan Cazenove) believe that as confidence in the domestic economic recovery builds, this underweight position in SA banks should be reversed."

This article first appeared in Stanlib's Weekly Focus

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