Take a look at banks in 2018 for income

This peculiar dynamic was first floated by Yale Hirsch of the Stock Trader’s Almanac in 1972 and is usually applied to the S&P 500. The trouble is that its chances of success appear to have receded since the start of the millennium and the correlation has never really played out with equity markets outside the US. This is not to be confused with the ‘January Effect’ which describes the tendency of small caps to outperform the benchmark index during the month.

One correlation with a more compelling provenance is the inverse relationship between interest rates and stock prices. If the Bank of England pays more than lip service to the target 2 per cent inflation rate, we may get some idea of the extent to which the low cost of capital has underpinned stock market valuations over the past few years. You get some idea by the increased volatility levels affecting loftily rated tech indices whenever the US Federal Reserve takes a more hawkish line on rates.

But it’s never one-way traffic; some sectors derive direct benefits from a rising rate environment. Earnings for banks and mortgage providers can increase as interest rates move higher, simply because they can charge more for lending. For insurers, higher rates typically boost investment income and stabilise the value of their long-term liabilities. So, if interest rates creep up through 2018, or even if that’s thought likely, it should increase the chances of rising earnings and dividend payout rates across the financial services sector, particularly in banking.

Analysts at Deutsche Bank have already floated the possibility of Royal Bank of Scotland (RBS) reinstating its dividend in respect of its 2017 results, although some investors would remain circumspect due to outstanding litigation issues in the US. And there has been speculation that Barclays (BARC) might step up its return to shareholders on the back of projected earnings increases, but that seems a less realistic prospect following a third-quarter update detailing what we described as a “lacklustre revenue-generating performance”. More worrying, the results of recent Bank of England stress tests showed both Barclays and RBS just scraping past statutory capital requirements.

Prospects for Lloyds Banking (LLOY) are more positive, at least according to industry analysts at UBS, who see a strengthening share price performance, fuelled by the prospect of further substantial increases in the dividend payout rate. The analysts are encouraged by the potential for strong capital generation, which chimes with the third-quarter review of Lloyds by our banking analyst Emma Powell, who also pointed out that “crucially for the maintenance of the bank’s progressive dividend policy, its CET1 ratio improved to 14.1 per cent, from 13.5 per cent year on year”. The good news is that despite fears, the recent introduction of the IFRS 9 accounting standard, which allows recognition of impairment provision even when the chance of a loss is minimal, is unlikely to result in a tangible increase in capital requirements.

But external issues could hamper the ability of the banks to boost their dividend payments. The Institute of Directors (IoD) thinks that London’s economy will underperform the regions due to weaker consumer spending and Brexit effects. For London read ‘financial services’, which are disproportionately affected by an exacerbated skills shortage and uncertainties over the issue of ‘passporting’. The EU passporting system for banks and financial services companies allows firms that are authorised in any EU or EEA state to trade freely in any other with minimal additional authorisation.