A rally that has seen European bank stocks outpace both US peers and the Nasdaq over the last three years faces a key test in coming days when most of the region’s major lenders report results.
Optimism over rising earnings and increased capital returns has formed the basis of gains that have extended this year. A 17% rise in the Stoxx 600 Banks Index is the strongest of any sector, taking it to its highest closing level since 2015.
Now, it’s time to deliver. And the omens look positive. The highest interest rates in recent memory have been a boon for profit, while signs that the cost of money will stay higher for longer serve as a further potential catalyst. Dividends and buybacks are a further attraction for investors, as are sector valuations that remain low relative to history and broader markets.
All of that isn’t lost on stock pickers. M&G’s European strategic value funds are running the largest overweight position on European banks since they started 16 years ago, according to fund manager Richard Halle.
“Our anticipation is earnings forecasts are likely to be resilient,” Halle said. The sector is pricing in “quite a few” interest-rate cuts in Europe this year.
This year’s gains by European banks represent an extension of a rebound that is now stretching into a fourth year, following more than a decade of underperformance.
With a gain of 82% since the end of 2020, the Stoxx 600 Banks Index has beaten everything from US technology stocks to US lenders, and the likes of UBS Group AG, Deutsche Bank AG and Banco Santander SA have recently hit multi-year highs. European banks are the only sector in Europe or the US to have outperformed every year since 2021 and so far this year, according to Berenberg strategists.
Key to future performance will be the actions of the European Central Bank, whose unprecedented hiking cycle has boosted lending margins for banks that mostly rely on net interest income as a source of revenue. With the central bank now preparing to ease, potentially starting in June, the terminal level of rates will be important in determining earnings sustainability.
Banco Santander SA Chairman Ana Botin predicted last week that terminal rates will be around 3% in Europe and 4% in the US, which is “not a bad thing for commercial banks.” Such a rosy scenario has been described as a “better for longer” backdrop by Goldman Sachs Group Inc. analysts.
And yet from a valuation standpoint European banks remain one of the region’s cheapest sectors, trading at 7.4 times forward earnings, similar to levels seen during the global financial crisis. That’s a 45% discount to the broader market and 35% cheaper than US peers.
Not everyone is upbeat. Barclays Plc analysts led by Paola Sabbione say the sector’s strong performance means it “could be more exposed to a volatile results season, where any earnings misses are punished meaningfully by the market.”
Bloomberg Intelligence expect the first quarter to show “sluggish net interest income trends” and to confirm a reversal in the earnings-upgrade cycle.
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