Banks back in favour
Fund managers are overweight banking stocks for the first time since 2007. But Maha Khan Phillips finds that not everyone is convinced that now is the time to buy
Fund managers are net overweight in global banking stocks for the first time in six years, according to a January survey from BofA Merrill Lynch. The firm surveyed fund managers with $754bn (€560bn) under management, and revealed that it believes banks to be the most undervalued sector in the global equity market.
“I’ve been underweight banks from about 2006 but moved overweight from the summer of 2012,” says Simon Murphy, UK equity fund manager at Old Mutual Global Investors. “For me, it felt like the positives were starting to take ascendancy for the first time.”
When Greece teetered on the brink of collapse in the summer of 2011, investment managers began retreating from the market. At the end of 2011, banks in the Dow Jones Stoxx Europe 600 index were trading at 0.57 times book value, their lowest since February 2009.
But things have improved recently. In January, the Basel Committee’s decision to push back the deadline for the liquidity coverage ratio (LCR) by four more years helped sustain a bull market in the Stoxx 600 Banks index that began in July 2012. Policy makers have also extended the range of approved assets which can be counted as liquidity buffers.
Elsewhere, the December minutes of the US’s Federal Open Market Committee (FOMC) meeting revealed that several members thought winding down the Federal Reserve’s quantitative easing programme by the end of 2013 would be a good idea. Combined with an undertaking to keep near-term rates low, the expectation is for a steepening yield curve that would provide easy profits for banks.
“I do think the rally in financials is justified and will be sustained,” says Dean Tenerelli, European equity portfolio manager at T Rowe Price. Perceptions about sovereign risk have improved in Europe as well, he observes. “Financials will outperform over the next few years. Part of the reason why banks were trading so cheaply was the sovereign risk issue. Then banks needed to hold more capital [for Basel III].”
Tenerelli is not the only manager buying bank stocks. Carmignac Gestion, the €54bn Paris-based manager, invested in five banks in France, Italy, and Spain after the ECB announcement of its outright monetary transactions (OMT) programme in August last year.
“The banks in which we chose to invest had largely restructured their off-balance sheet transactions and had made sufficient recapitalisations,” says Sandra Crowl, member of the investment committee. The fund has been investing in US banking debt for most of 2012, and in bank equity since the beginning of this year. “While both the US and European bank markets are valued on similar multiples, we structurally prefer the US market, giving better return on capital through dividends and share buybacks. They are cyclically ahead of their European peers, particularly in regard to the mortgage cycle.”
However, Crowl argues that the European recovery anticipated by economists for the second half of 2013 seems optimistic, and that the political risk with German and Italian elections coming up this year must not be discounted.
“Above all, Greece is still on an unsustainable debt path, the Cypriot bailout has not been approved and we are a long way off from a Europe-wide banking union, with a centralised deposit insurance scheme and a bank resolution regime,” she warns. “Until we see a sustained recovery from what is still a European recession, the more pro-cyclical portfolio weighting, including bank stocks, will just be tactical.”
Other managers believe that risk has been factored in after five years of banks de-leveraging and the pursuit of profit rather than growing market share.
“The competitive dynamic has improved significantly because of de-leveraging of balance sheets and the move back to core businesses,” says Robert Mumby, financial equities fund manager at Jupiter Asset Management. “It’s a good time to overweight financials stocks. There are plenty of financials other than banks that are doing well and are good investments.”
There are still investors who believe such enthusiasm is dangerous. Neil Dwane, Europe CIO for Allianz Global Investors, says the Basel III delays are not a positive thing.
“In my opinion it shows that, firstly, banks have not sufficient capital or liquidity of their own and therefore are asking for more time; and secondly, that banks have been able to use their political power to get regulators to soften the terms of regulation,” he argues.
Even those who take a positive view of banks’ positions with regard to progress towards Basel III implementation have to ask themselves whether this is a positive thing for banks’ equity. For the next few years they will have to build up capital organically and continue to de-risk, as Roger Doig, bank debt analyst at Schroders, points out. “That is positive from a creditor perspective but not so positive from an equity perspective.”
That might be one reason why Dwane suspects that Basel III requirements could be repeatedly delayed, as banks complain that it is too tough to meet the standards.
“Four years after the global financial crisis we are still not going to have adequately capitalised banks that won’t blow up the world again,” he says, drawing attention to the fact that the management in charge of banks when the financial crisis hit is still at the helm.
“At Barclays and UBS, you had a wholesale repudiation of the previous management,” he concedes. “But at Goldman Sachs and JPMorgan and Deutsche Bank you still have the people that rode us over the cliff in charge, telling us that they are in control and they won’t do it again. I sit here thinking, you didn’t know you were doing it in 2007 and 2008 and you don’t know it today.”
And Dwane doesn’t believe that ECB president Mario Draghi’s comments about doing everything necessary to save the euro were reassuring, either.
“Draghi hasn’t done anything,” he insists. “He just said ‘I will do what it takes’. That was sensationally effective. But he’s not walking the walk.”
While Dwane agrees that US banks are in better shape than their European counterparts, he also points out that they remain “enormously exposed” to their European counterparts. He says that he holds no banks in his portfolio.
That can be a lonely position at times like this, when something like animal spirits are driving the markets. Will that position be vindicated over the longer term? That depends on how badly damaged we think Europe’s sovereigns and banks really are – and how much of that damage is already in the price of bank equity.