When asked what knocks governments off course, former British prime minister Harold Macmillan allegedly replied, “Events, dear boy, events.” What a week it’s been for events, as stock markets surged in response to two crucial developments. First, Joe Biden won a close US presidential election. Second, news arrived yesterday of an effective vaccine against Covid-19. Yet, even as stock markets soar, I see cheap shares aplenty lurking in the FTSE 100 index.
The FTSE 100 surges 11%
On Monday, the FTSE 100 closed at 6,186 points, up 276 points (4.7%), having peaked above 6,258 following the news. Also, the FTSE 100 has leapt over 540 points (6.6%) in five trading days, a jump of almost a tenth. But despite this bounce-back, the Footsie has dived over 1,350 points (18%) in 2020, with this year shaping up to be among the worst in the index’s 36-year life. Meanwhile, the US S&P 500 is actually ahead 11.5% in 2020, leading me to believe there are plenty of UK cheap shares just waiting to be bought.
2020 has been bad for banks
Thanks to social restrictions to control Covid-19, it’s been a punishing year for British banks. We Brits have been saving instead of borrowing, while falling interest rates have eaten into banks’ profit margins. Also, millions of borrowers have taken payment holidays on mortgages, loans and credit cards. Likewise, the Covid-19 crisis has finished off many struggling businesses. Hence, the cheap shares of UK banks just kept getting cheaper.
Yet there remain some bright spots amid the endless gloom. The housing market is booming, with transactions climbing as buyers race to beat the return of Stamp Duty Land Tax next April. In fact, residential property is undergoing a buying boom not seen since 2007. Furthermore, banks’ third-quarter results came in way better than expected, as profits surged and bad-debt provisions dived in the summer rebound. That’s why I think several cheap shares are hiding in the banking sector.
Cheap shares: banking on Barclays
Barclays (LSE: BARC) is one cheap stock I’ve had my eye on since the summer. As well as being one of the ‘Big Four’ clearing banks, Barclays has an investment-banking arm making bumper profits from market volatility. This helped it to record a pre-tax profit of £2.4bn in the first nine months of 2020. In addition, Barclays has a fortress balance sheet, with a Common Equity Tier One ratio of 14.6%. That’s 3.3% percentage points above the regulatory minimum of 11.3%.
Barclays shares crashed to a mere p on 19 March, putting them among the cheapest of cheap shares in the FTSE 100. On Monday, they closed at 128.54p, up 17.6p (15.9%) in one day. That’s an impressive recovery, but I’m sure there’s more to come. After all, this stock ended 2019 at 179.64p, almost 50p above the current price. Also, at its 52-week high of 16 December 2019, Barclays’ share price was almost exactly 50% higher than its current level.
Today, I’m still of the opinion that Barclays stock is selling too cheaply. When we move to a post-Covid-19 world and the economy recovers, Barclays’ profits should surge. Only then will the bank regulator allow it to resume paying cash dividends. When this happens, I anticipate a dividend yield in the mid-to-high single digits. Hence, banking on a recovery that generates handsome dividends and capital gains, I’d buy these cheap shares today. Ideally, I’d buy inside an ISA for tax-free returns for years to come!