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The stars are finally aligned for banks

Written by Christina Carlsten, Analyst Fund Manager | Feb 18, 2023 11:00:00 PM

Bank stocks and a recession – could this time be different?

There’s an old saying that you shouldn’t buy bank stocks in the run-up to a recession. But could things be different this time around?

Compared with previous recessions, this time we’re starting from a very different place, since banks today are much better positioned. For one thing, they’ve significantly increased their capital ratios in response to stricter regulatory requirements, and for another, they set aside hefty provisions during the pandemic and are now cutting costs.  

The winners of the current rate hike cycle

The negative perception of banks has been changing over the past few months. While the prospect of higher interest rates is worrying for financial markets, and especially equities, there will be some winners: European banks. After long years of negative interest rates, this new cycle of rate hikes will provide a major boost to banks, and especially their profits, with their net interest margins set to increase substantially in the coming years. This is starting to show in banks’ earnings – recent figures have been solid and received a warm welcome from investors. The consensus estimates were much too pessimistic, and now earnings forecasts are being revised upwards dramatically.

The eurozone’s economic outlook

Bank stocks are some of the most sensitive to the macro cycle, meaning they’ve been buoyed by the recent improved sentiment about the eurozone’s economic prospects. The more sanguine outlook is due to the decline in natural gas prices since last summer and the resilience of the region’s economic indicators, in a climate that nevertheless remains challenging. We believe the sharp rise in interest rates will more than offset a likely increase in impaired loans resulting from the worsening economic conditions – although for now that increase seems limited. It’s also worth noting that several European governments have announced sizeable stimulus programmes to help consumers cope with rising prices. This will also be beneficial to banks.

Est-il trop tard pour acheter les banques ?

European equities had a stellar start to the year, and the banking sector was no exception. There are two main reasons why we think the upward trend in bank stocks will continue. First, their valuations are extremely attractive given, since these stocks are still trading at levels close to those seen during the 2008 and 2011 crises. And because banks are better positioned today, we should see a rise in their P/E ratios. And second, they harbour catch-up potential relative to the recent rise in bond yields.

Today it makes a lot of sense to invest in European banks. Not only will the sector be among those with the highest level of share buybacks in 2023, but it also stands to be boosted by monetary policy tightening and fiscal stimulus.

 

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