MILAN, April 28 (Reuters) – Expectations of rising interest rates have failed to lift valuations of European bank stocks, which are languishing at nearly two-decade lows, as deteriorating growth prospects weigh on the broader financial sector.
Rising bond yields are a boon for banks as they tend to increase interest income, but the strongest two-month rise in borrowing costs across the euro zone since 1994 has not translated into equity market outperformance for banks.
An indicator for European bank stocks (.MIEU0BK00PEU) is down 6% since early March and is not far off 14-month lows hit last month as the war in Ukraine has raised prospects for the region in draw a recession.
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This underperformance has also opened a huge gap with the historically high positive correlation with bond yields, a sign that there may be room for a recovery. A 90-day correlation between MSCI Europe Banks and 10-year German bond yields is at its lowest in over nine years, according to Refintiv data.
US banks have also seen a similar trend, albeit to a lesser extent, despite the rise in Treasury yields.
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“This is currently one of the big topics among investors and keeps us on our toes. The correlation has worked very well in the past and that it is now broken cannot be fully explained by macro or geopolitical factors,” said Jerome Legras, Head of Research at Axiom Alternative Investment in London.
Even as they recover from the 2020 pandemic lows, European banks are currently trading nearly 40% below their 18-year average valuation, based on a price-to-book metric, according to Refinitiv data. They trade at 0.3 times the broader market, which is also a discount of nearly 40% to the 18-year average.
“The only thing that would justify these levels would be if we are headed for a recession. That’s what stocks are pricing in, but right now there’s no economist, no other indicators,” he added.
UBS (UBSG.S) just posted its best gain in 15 years and Deutsche Bank (DBKGn.DE) continued its longest winning streak since 2012, despite geopolitical and macroeconomic uncertainties clouding the outlook. Continue reading
The concern is that rising commodity prices and rising interest rates could lead to a slowdown in economic activity, which could lower transaction volumes and fees for banks, while headwinds mount as companies struggle to repay debt.
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NOT ENOUGH
Against this backdrop, Generali Investments, with around 583 billion euros ($613 billion) in assets under management, recommends a neutral allocation to banks, even if valuations look attractive.
“Typically, banks need three pillars to be successful: higher yields, moderate credit spreads and accelerating GDP growth.
A London-based hedge fund trader estimates that a 20 basis point increase in the cost of risk would negate the benefits of a 100 point interest rate move.
The ECB is expected to hike rates by 80 basis points by the end of 2022, but policymakers are cautious. The Bank of Spain warned that the Ukraine conflict would have a significant indirect impact on the country’s economy and banks. Continue reading
Certainly, the positioning of investors in the futures markets indicates a return of some optimism for banks over the past week.
“We believe bond yields and the direction of inflation will realign with growth, as was the case before the geopolitical shock,” said JP Morgan strategists. “This is to ensure that correlations return to historical norms and fill in the gaps that are now apparent.”
But that can take time. Banks experienced one of the worst 12-month forecast EPS revisions among European sectors since Russia invaded Ukraine, according to Generali Investments. A move to halt gas supplies to Bulgaria and Poland this week has only heightened recession worries.
“If I had to build a new portfolio from scratch now, it would be underweight financials… European growth this year will be significantly lower than expected a few months ago simply because of this war and the price of oil,” said Jerome Schupp, Portfolio manager at Prime Partners in Geneva.
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($1 = 0.9515 euros)
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Reporting by Danilo Masoni in Milan, Julien Ponthus and Samuel Indyk in London; Edited by Saikat Chatterjee and Jane Merriman
Our standards: The Thomson Reuters Trust Principles.
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