To invest in the banks is to go so against the grain for European investors that they’d even prefer the auto sector in comparison. But is this justified?
Banks have been one of the worst performing sectors in 2018. In the words of one Citi strategist they are "at the bottom of 297 global sectors over the last 10 years; banks in Europe remain the world’s biggest contrarian trade."
Looking at valuation metrics compared to the market (price-to-earnings ratios, or price-to-book ratios) the banks are at or close to 30-year lows. At current levels, banks would appear to be pricing in a global downturn and are being given no credit for the significant improvements they have made since the global financial crisis.
The low valuation of many European banks suggests a dislocation between investors’ perceptions and the actual fundamentals. However, this is at odds with recent improvements in the European economy – an important factor in the banking industry’s dynamics. The banks have significantly strengthened their capital positions since 2008-09 and, in doing so this has improved their profitability. From an income perspective, dividend growth and dividend cover appear attractive in our view for a number of European financial names.
As more monetary policymakers indicate a willingness to raise rates in the future, this can provide a future benefit to banks’ margins. This is because rising rates tend to indicate a strengthening economy, allowing banks to earn more through lending than they would otherwise lose through higher savings account rates.
Of course, no investment comes without risk. The political and economic tensions around Italy, covered most recently by our economists, present a clear and present danger in investors’ minds. The populist government is proposing additional spending when its debt levels are already very high. If this leads to clashes with the EU and serious fears of Italy leaving the Eurozone then investors will continue to shun banks.