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The Stoxx 600 Banks Index has surged 25% this year, its best three months since 2020. That's made it the top-performing sector in Europe by far as investors keep increasing their exposure, and strategists see more gains ahead.
Their appetite is being driven by series of factors: firstly strong earnings seasons, hefty share buybacks and M&A potential, and now massive public spending plans that will probably keep European interest rates high. Over a 10-quarter winning streak — the longest since before the financial crisis — banks have returned over 160% including dividends, triple the 52% for the broader Stoxx Europe 600.
'The operating environment is very different today to almost any time over the past 20 years – we have banks talking about loan growth again, an upward sloping yield curve and governments at least talking about reducing the regulatory burden,' said Keefe, Bruyette & Woods's head of European bank research Andrew Stimpson. 'That likely means there is still more good news.'
Following this run, some bears had expected lenders' outperformance to start fading, particularly as central banks are now cutting rates. Instead earnings have proved their business remains resilient, while buyback programs are also driving up shares. The likes of Societe Generale SA, Commerzbank AG and Banco Santander SA — repurchasing their own shares — have climbed more than 40% this year.
The latest tailwind has been Germany passing a landmark spending package, creating a potentially unlimited supply of money to rearm to deter Russia. It will also set up a €500 billion ($540 billion) fund to invest in the country's aging infrastructure. The country's banks are set to benefit, with Deutsche Bank AG jumping 35% this year to trade near 10-year highs.
'The shift in fiscal policy will likely drive a stronger outlook for loan growth given the increased government expenditure on defense, infrastructure, and state/local projects,' JPMorgan Chase & Co. analysts led by Kian Abouhossein wrote in a note. They expect a long term re-rating for lenders in the region.
The geopolitical landscape, along with cooling inflation, are reducing the chances of the European Central Bank cutting rates below 1.5%, implying less pressure on lending revenue, the JPMorgan analysts said. While the ECB this month lowered rates for the sixth time since June, it indicated its cutting phase may be drawing to a close.
The combination of lower rates and longer-term government borrowing plans has steepened the German bond yield curve the most since 2021. That means banks are able to borrow money at a lower cost and lend at higher rates.
Investors keep upping their exposure. According to Bank of America Corp.'s European fund manager survey this month, positioning in financials has increased, with banks now the largest sector overweight in Europe. And half of European investors think lenders still look attractive, up from 41% a month earlier, it found.
The last earnings season proved profitability remains robust. The sector delivered 'another quarter of positive surprises,' Jefferies analysts said, noting the solid performance of net interest income. The European Union's largest banks posted another record year for profit, while 20 banks in the region announced over €18 billion in share buybacks during the first two months of the year alone.
Mergers and acquisitions also remain a hot topic. Spain's BBVA SA is waiting for approval for its hostile bid for smaller lender Banco Sabadell SA, while Italy's UniCredit SpA has a move on both Commerzbank and Banco BPM.
Easy Money
Some analysts are questioning how long the positive fundamentals can last. After the series of stellar earnings seasons, profit growth is expected to plateau. The consensus for the sector sees very little return on average over the next 12 months, so the potential upside lies more with sentiment and valuation expansion.
For Roberto Scholtes, head of strategy at wealth manager Singular Bank, the banking rally has been sound and based on genuine improvement in profitability, but the 'easy money' has already been made. 'Valuations are no longer that cheap, expectations aren't depressed, investor positioning is already quite long, and net interest margins are at an inflection point,' he said.
Positioning is now a more crowded bet. Lenders were deeply overbought for much of January and February, and valuations are closing in on their long-term average.
The sector now trades at about nine times forward earnings, yet it remains the second cheapest in Europe after autos. Banks are also on par with their forward book value, only half the level seen before the global financial crisis, implying there is still room to run.
Deutsche Bank strategists including Maximilian Uleer and Carolin Raab are 'optimistic on banks given structurally higher bund yields, an economic recovery and a steeper yield curve.'
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