Volatility in equity markets has been elevated over the past couple of weeks as investors have been trying to stay one step ahead of world developments. For international firms trading on the FTSE 100, sensitivity to the US/China trade war has been seen. For more domestically-focused companies, Brexit has been the main driver.
This has particularly affected the share price of the Royal Bank of Scotland (LSE: RBS), which rose over 11% in trading on Friday. The question now is — should I buy or sell?
Why did it rally in the short term?
The main driver for the 11% gain was developments surrounding Brexit. Following a successful meeting between Boris Johnson and his Irish counterpart, it appears that the path towards securing an acceptable deal with the European Union is more likely. This would benefit domestic businesses as uncertainty would be taken away, with hopefully a smooth transition to a new trading status.
Further, it would also benefit the banking sector, as interest rates would likely not be cut any more and consumer spending could even increase. Investors therefore bought companies in the banking sector, particularly RBS, after the news came out during the week.
Will it continue to rally?
RBS outperformed other bank stocks yesterday, which may be a sign of pent-up demand that is benefitting RBS over others, for example HSBC and Barclays, in the current circumstances. One reason for this may be the international nature of other banks that may not benefit as much from a Brexit deal. With RBS being UK-focused, a Brexit deal would do significant good for the business across all its operations (private, commercial and institutional).
RBS does appear to have good longer-term prospects, regardless of Brexit. Alison Rose is due to take over as CEO next month and become the first female CEO of a major British bank. She has a solid track record, having been with the bank for over 27 years. Her strategy is yet to be seen, but she will be keen to show shareholders value.
What are the downside risks?
So what is the potential bad news? For a start — Brexit. While the 11% rally came on the back of a positive meeting from PM Johnson, this is only the beginning. There are still countless hurdles to negotiate before the proposed deal could be signed off. Lest we forget, the proposal would still need to be agreed by the EU and the Houses of Parliament. The House of Commons has not been supportive of previous deals so it looks like an uphill struggle.
For RBS, this means that the share price rally maybe premature. Any Brexit extension or even ‘no-deal’ would keep the cloud of uncertainty hanging over the banking sector and probably dampen the share price.
Further, two months ago RBS revised its 2020 financial targets, saying it was “very unlikely” to reach them. While the 2019 outlook appears ok, flagging concern over the longer term is not a positive sign for the bank.
Therefore I would personally hold off buying until we have more clarity on Brexit.
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Jonathan Smith has no position in the share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019