European bank stocks continue to be strong, and the quarterly market soars 25%, the best since 2020

The Zhitong Finance App learned that after another brilliant quarter, European bank stocks are still rising strongly. The Stoxx 600 Bank Index has soared 25% this year, making it the best three-month performance since 2020. As investors continue to increase their holdings and strategists expect more gains in the future, the index has become the best-performing sector in Europe so far.

Figure 1

The strong performance of bank stocks was mainly due to several factors. First, there is a strong profit season, huge share buybacks, and M&A potential. According to information, the profitability of the previous fiscal quarter was still strong. Jefferies analysts said the industry was “another positive surprise for the quarter,” and pointed to a steady performance in net interest income. The EU's largest bank recorded another record profit, and 20 banks in the region announced repurchases of more than 18 billion euros of shares in the first two months of this year alone.

Meanwhile, mergers and acquisitions are still a hot topic. Spain's BBVA SA is awaiting approval for its malicious takeover of small bank Banco Sabadell SA, while Italy's UniCredit SPA has taken over Commerzbank and Banco BPM.

Second, there are now large-scale public spending plans, which could keep interest rates high in Europe. In 10 consecutive quarters of gains — which was the longest cycle before the financial crisis began — the bank's return, including dividends, was over 160%, three times that of the Stoxx Europe 600 Index of 52%.

“Today's business environment is very different from any time in the past 20 years — banks are once again talking about loan growth, yield curves are trending upward, and the government is at least talking about reducing regulatory burdens,” said Andrew Stimpson, head of European banking research at Keefe, Bruyette & Woods. “That probably means there's more good news.”

The latest benefit is Germany's adoption of a landmark spending plan, creating an unlimited supply of capital. Germany will also set up a 500 billion euro (540 billion US dollars) fund to invest in the country's aging infrastructure. The country's banks will benefit. Deutsche Bank's stock price rose 35% this year, close to the highest level in 10 years.

J.P. Morgan analyst Kian Abouhossein and others wrote in a report: “Given the increase in government spending on defense, infrastructure, and state/local projects, a shift in fiscal policy is likely to drive stronger prospects for loan growth.” They expect banks in the region to be re-rated for a long time.

Analysts at J.P. Morgan Chase said that the geopolitical situation and cooling inflation have reduced the possibility that the ECB will lower interest rates below 1.5%, which means that pressure on loan revenue will decrease. Although the ECB cut interest rates for the sixth time this month since June, this indicates that the interest-rate cut phase may be coming to an end.

The combination of lower interest rates and longer-term government borrowing plans made the German bond yield curve steeper, reaching the highest level since 2021. This means that banks can borrow money at a lower cost and lend at higher interest rates.

In response, investors continued to increase their holdings. According to Bank of America's survey of European fund managers this month, there has been an increase in financial stock holdings. Bank stocks are currently the largest European sector. The survey found that half of European investors think bank stocks are still attractive, up from 41% a month ago.

However, some analysts have questioned how long the positive fundamentals will last. Profit growth is expected to stabilize after a series of excellent earnings seasons. The market generally believes that the industry's average return over the next 12 months will be very low, so the potential upside depends more on market sentiment and valuation expansion.

Some bearers had anticipated that banks' excellent performance would begin to subside, especially as major central banks were cutting interest rates. However, the profit proved that the banking business was still strong, and the buyback program also boosted stock prices. Banks such as Société Générale, Commerzbank, and Santander have increased their stock prices by more than 40% this year by buying back their shares.

It is worth mentioning that Roberto Scholtes, head of strategy at wealth management company Singular Bank, believes that the rebound in bank stocks is steady and based on real improvements in profitability, but “easy money making” has arrived. “Valuations are no longer that cheap, expectations have not been suppressed. Investors' holdings are already quite large, and net interest spreads are at an inflection point,” he said.

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The warehouses are now more crowded. Bank stocks were overbought for most of January and February, and valuations are approaching their long-term average.

The industry's current price-earnings ratio is about nine times the expected price-earnings ratio, yet it is still the second-cheapest sector in Europe after the automotive industry. The bank's price-earnings ratio is also comparable to its expected book value, only half of what it was before the global financial crisis, which means there is still room for growth.

German bank strategists Maximilian Uleer (Maximilian Uleer) and Carolin Raab (Carolin Raab) said, “They are optimistic about banks given the structural rise in German treasury yields, economic recovery, and steeper yield curves.”