The apparent de-escalation of the trade dispute between Washington and Beijing sparked a technical breakout for stock indices around the globe in October 2019. Above all, the manufacturing-intensive regions such as Asia and Europe, have gained considerable potential to stage catch-up rallies in response to this development. Alas, the onset of the novel coronavirus (Covid-19) has put this move on hold for now, but it by no means has affected the underlying fundamental recovery. The recent decline in the daily reported number of new infections is reason for hope, and investors are starting to view the disease merely as a temporary glitch in an otherwise robust global economy. This optimism is also extending to the banking sector in Europe, not only due to an increasing appetite for risk: as we all well know, the sector has been fundamentally undervalued for quite some time. Since almost a decade now, banks on the Old Continent have generally been avoided due to the weak-kneed situation within the European financial industry. The financial sector’s performance to date is reflecting this development. However, their latest earnings reports speak a more upbeat lingo.
In connection with the current round of reporting on their Q4 2019 financial results, almost half of the European banks come away in a better than expected light. Universal banks beat analysts’ earnings expectations by 13%, and financial services providers managed to exceed those forecasts by more than 24%. Another surprise: almost all banks that have reported to date are equipped with a more solid capital base – an important factor for investors who are keen on profit distributions, as it makes those institutions a considerably safer bet going forward. This strong operating trend has also been evident in the first few weeks of the current financial year. Equally spoken, the positive ray of hope here should not disguise the fact that an industry-wide metamorphosis is placing tremendous demands on banks in Europe, and that operational uncertainties persist to this very day. However, the valid question arises as to whether the current fundamental undervaluation of these institutions can still be reconciled with their quite impressive operating performance.
At an average of 8.6, the P/E reading for banks in Europe is currently a full standard deviation below the five-year mean, whilst profit margins lie one notch higher. And with their improved capital strength, European banks should also be able to offer their shareholders a solid dividend. At an anticipated rate of 6%, their average dividend yield is exceptionally attractive not only in view of the persistently negative interest environment, but also because it is 2.5% above the overall European equity market.
Simultaneously, the European share indices are in the process of shattering all the highs of the past two decades as well as totally recouping the consolidation that marred the charts since 2018. This breakout foretells further price potential. Given the European banking sectors’ low fundamental valuation and improving operating strength, we believe there is the possibility for a 25-30% reflex rally in these stocks.
For more information on the proposed products, please contact your client advisor.
Bernd Hartmann, Head CIO Office
Harald Brandl, Senior Equity Strategist
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