When bank shares do move up, they tend not to hang about, concludes, Jeff Taylor

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1 When bank shares do move up, they tend not to hang about, concludes, Jeff Taylor November 218 This marketing document is exclusively for use by Professional Clients and Financial Advisers in Continental Europe (as defined in the important information) as well as by Qualified Investors in Switzerland. This document is not for consumer use, please do not redistribute. Please read the Risk Warnings that appear on page 5. Being overweight banks has not been particularly helpful to the performance of the products managed by the Henley European Equities Team in the last six months. The broader market had a bout of nerves about a spell of softer economic data earlier in year, but seems to be overlooking signs of macro stabilisation and improvement more recently. Whoever succeeds Mario Draghi must, by definition, be more hawkish. The market is concerned about Italian politics without really thinking too hard about the valuations that Italian stocks (especially banks) have already reached, nor taking into account the fact that a very clear majority of Italians are in favour of the euro. Bank shares have been held back by Draghi s comments earlier in the year on the timing of a first ECB rate rise, which have definitely kept a lid on rate expectations yet the 12-month Euribor has, all the same, risen marginally since the beginning of the year and on current trends will soon be up year-on-year. The market is pricing in that rates will stay negative until long after the end of Draghi s tenure, but this seems counterintuitive given that whoever succeeds him must, by definition, be more hawkish. Turkey s turmoil has ramifications for a small handful of European banks with operations there, but the impact on their share prices has already more than built in any credible hit to capital ratios. 1

2 The one period of stress when banks did well was the period associated with a change in the direction of US monetary policy: an interesting precedent for Europe perhaps? What could or should happen next? So, how does the recent underperformance of banks stack up against other periods of market stress? Does history give us any clues about what could or should happen next? We found the following charts from the banks team at Deutsche Bank interesting. In figure 1, the left chart shows that the scale of recent underperformance is now fast approaching that seen in 215/216 when the market was also fretting about an imminent slowdown in global GDP growth. Current market stress has indeed not led to bank underperformance of the magnitude seen in the global financial crisis (GFC) and the eurozone crisis, but nor should it, given the systemic nature of financial stress during those periods. As a reminder, it was the aftermath of the GFC that gave us the opportunity to start to move from being underweight to being overweight in banks something that we increased significantly during the eurozone crisis sell-off. Interestingly, the one period of stress when banks did well was the period associated with a change in the direction of US monetary policy: an interesting precedent for Europe perhaps? Figure 2 shows how sharply the market can change its mind about the attractions of investing in this sector, when the worst is deemed to be past. Figure 1: Stoxx Europe 6 Banks performance relative to market during periods of stress Global Financial Crisis (June 8 March 9) EZ Crisis (July 11 June 12) Taper Tantrum (May 13 February 14) RMB Shock + Commodities (May 15 February 16) Recent Stress (February 18 onwards) /8 3/9 7/11 6/12 5/13 2/14 5/15 2/16 2/18 onwards Source: Deutsche Bank, Bloomberg as at 28 August 218. Figure 2: Stoxx Europe 6 Banks performance relative to market 12 months after periods of stress 8 Global Financial Crisis (June 8 March 9) EZ Crisis (July 11 June 12) Taper Tantrum (May 13 February 14) RMB Shock + Commodities (May 15 February 16) Recent Stress (February 18 onwards) 6 4 2? -2 6/8 3/9 7/11 6/12 5/13 2/14 5/15 2/16 2/18 onwards Source: Deutsche Bank, Bloomberg as at 28 August

3 Any reasons to be more cheerful? We could spend a long time on the subject of valuation depressed bank P/E relatives despite improving earnings momentum, very depressed P/B multiples relative to the US despite improving ROEs (return on equity) in prospect, sky-high market-implied COEs (cost of equity), high dividend yields despite the fact that balance sheets and capital ratios are significantly stronger than at the time of the GFC. However, here s just one chart that eloquently makes the point: figure 3. Here we can see that lows coincide with the GFC, eurozone crisis, global slowdown worries and Brexit vote. As banks are, in the end, cyclical animals, it s perhaps equally telling to look at a couple of growth-related charts as well. Banks relative performance is ignoring the bounce: an anomaly, we feel. Figure 4, which was very much in vogue earlier in the year when it could be interpreted as a sign of Europe disappointing, is the CESI (Citi Economic Surprise Index) for the eurozone, which measures economic data surprises relative to market expectations. Frustratingly, it seems to be getting little air time now that the eurozone s momentum is picking up again. Having tracked the CESI down earlier in the year, banks relative performance is ignoring the bounce: an anomaly, we feel. Figure 3: Relative valuation of banks vs the European market close to lows % /3 12/6 12/9 12/12 12/15 12/18 Source: Datastream, IBES consensus, as at 29 August month forward P/E relative valuation (Euro Stoxx Banks vs Euro Stoxx). Just because banks haven t worked as well as we were hoping they would in recent months doesn t mean they won t work at all. Figure 4: Citi Economic Surprise Index for eurozone & relative performance of banks versus MSCI Europe ex UK Index CESI Eurozone (LHS) MSCI Europe ex UK: perf. of Value relative to Growth since 31 December 17 (%, RHS) /17 1/18 2/18 3/18 4/18 5/18 6/18 7/18 8/18 Source: Datastream, Citi, Invesco, as at 27 August

4 Rising business expectations Figure 5 shows the recent sharp upturn in one of the most followed macro indicators in Europe: Germany s IFO Business Climate Index. The overall business climate reading reflected that companies were more satisfied with their current business situation, but revised their assessment of their future prospects up noticeably. To go deeper into the details, the overall manufacturing component rose in August after six months of consecutive declines, with companies planning to step up production. In the service sector, companies expectations were noticeably more optimistic, with the expectations component rising at the fastest pace in over nine years. That sounds like a generally sound environment for European banking to us, but the equity market has yet to get round to reflecting it Figure 5: MSCI Europe ex UK Index banks performance relative to market & German IFO Business Survey Rel perf of MSCI Europe ex UK banks relative to MSCI Europe ex UK (RHS, 1 = January 211) IFO Business Expectations IFO Business Climate (overall) Euro Area MUICP All Items YoY NSA /11 8/11 3/12 8/12 5/13 12/13 7/14 2/15 9/15 4/16 9/16 6/17 1/18 8/18 Source: IFO Institute, Datastream, Invesco, as at 27 August 218. Conclusion: sector comeback is overdue Just because banks haven t worked as well as we were hoping they would in recent months doesn t mean they won t work at all. The multi-year rally in European financials after the eurozone crisis and the more modest, shorter move up after the Brexit referendum result show that when bank shares do move up, they tend not to hang about. Fundamental analysis and our resolute adherence to our valuation-focused investment approach tell us that a re-appraisal of the sector by the market is overdue. We are staying put and biding our time. Jeffrey Taylor, Head of European Equities, Henley Investment Centre 4

5 Contact Amsterdam Brussels Frankfurt Madrid Milan Paris Vienna Zurich Risk Warnings The value of investments and any income will fluctuate (this may partly be the result of exchange-rate fluctuations) and investors may not get back the full amount invested. Important Information This marketing document is exclusively for use by Professional Clients, Financial Advisers and Trade Press in Continental Europe (as defined below) as well as by Qualified Investors in Switzerland. Data as at , unless otherwise stated. This document is not for consumer use, please do not redistribute. By accepting this document, you consent to communicate with us in English, unless you inform us otherwise. Where individuals or the business have expressed opinions, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. Further information on our products is available using the contact details shown. As with all investments, there are associated risks. This document is by way of information only. Asset management services are provided by Invesco in accordance with appropriate local legislation and regulations. For the distribution of this document, Continental Europe is defined as Austria, Belgium, Finland, France, Germany,Italy, Luxembourg, Netherlands, Norway, Spain, Sweden and Switzerland. This document is issued in Germany by Invesco Asset Management Deutschland GmbH, An der Welle 5, D-6322 Frankfurt am Main, Germany; in Austria by Invesco Asset Management. Österreich Zweigniederlassung der Invesco Asset Management Deutschland GmbH, Rotenturmstrasse 16 18, A-11 Vienna, Austria; in Switzerland by Invesco Asset Management (Schweiz) AG, Talacker 34, CH-81 Zurich; in Belgium, Finland, France, Italy, Luxembourg, Netherlands, Norway, Spain and Sweden by Invesco Asset Management S.A., rue de Londres, 759 Paris, France. EMEA8683/218 Read more articles from the Euro Zone News: A map for the future of the euro The future of the euro and of the EU are essentially one and the same, say Arnab Das and Jacek Rostowski. No mandate for Italexit Concerns around Italy have moved the European credit market. In our authors view, an Italian exit from the EU is quite a remote possibility. Down but by no means out Economic growth in the eurozone should remain above the potential growth rate, argues Mark McDonnell. Heavy lifting ahead Corporate responsibility has moved from a voluntary to a statutory expectation, with asset managers at the centre. In favour of factors? Earnings Momentum and Price Momentum, Quality, Value: Which factors might be favoured in an environment of rising interest rates? 5