Bank stocks – According to analysts, major economies may well stall or suffer a recession.
As a result, in 2023, investors are breaking with tradition and flocking to large bank stocks.
From January and late February, the Stoxx Europe 600 Banks index, which comprises 42 major European banks, surged by 21%.
It surpassed its bigger benchmark index, the Euro Stoxx 600, to set a five-year high.
Yet, the KBW Bank, which monitors 24 of the top American banks, gained by 4% in 2023, outperforming the S&P 500 by a wide margin.
Since their lows in October, the two bank-specific indexes have climbed.
So far, the economic condition is less advantageous.
Compared to last year, the main economies in the United States and the European Union are predicted to grow slightly.
However, output in the United Kingdom is expected to decline.
Former Treasury Secretary Lawrence Summers feels that a quick recession is dangerous for the United States at some point.
But, as a result of widespread economic weakness and unsustainable inflation, central banks were forced to raise interest rates.
In any event, it has helped banks by allowing them to generate bigger profits on consumer and business loans as savers deposit more money into savings accounts.
While rate hikes have kept major banks’ stocks steady, fund managers and analysts believe investor and analyst confidence in their ability to weather economic storms since the financial crisis of 2008 has also played a role.
“Banks are, generally speaking, much stronger, more resilient, more capable to [withstand] a recession than in the past,” said Roberto Frazzitta, the global head of banking at Bain & Company.
Interest rate increases
When major countries’ interest rates climbed last year, governments launched steps to curb growing inflation.
The significant hikes followed a period of low borrowing costs that began in 2008.
The financial crisis wreaked havoc on the economy, prompting central banks to lower interest rates to historic lows in order to spur consumption and investment.
For more than a decade, central banks have done nothing.
In an environment where lower interest rates suggest fewer lender earnings, investors seldom bet on banks.
According to Capital Economics’ senior markets economist, Thomas Matthews:
“[The] post-crisis period of very low interest rates was seen as very bad for bank profitability, it squeezed their margins.”
But, the rate rise cycle starting in 2022, as well as a few signs of weakening, shifted investors’ expectations.
On Tuesday, Fed Chair Jerome Powell warned that interest rates may rise quicker than expected.
Read also: Mary Daly says more rate hikes is needed, gold price paused
Investors have been attracted to the higher possibility for shareholder profits.
The average dividend yield for European bank equities is currently 7%, according to Ciaran Callaghan, Amundi’s director of European market research.
According to Refinitiv data, the S&P 500 dividend yield is at 2.1%, while the Euro Stoxx 600 yield is 3.3%.
Additionally, European bank stocks have surged in the recent six months.
Capital Economics outperformed its American rivals, according to Thomas Matthews, because interest rates in countries that use euros are closer to zero than in the US, meaning that investors have more to gain from increasing rates.
He also stated that it may be ascribed to Europe’s unexpected turn of events.
Wholesale natural gas prices in the region hit a record high in August of last year, but have since returned to pre-Ukraine war levels.
“Only a few months ago, people were talking about a very deep recession in Europe compared to the US,” said Matthrew.
“As those worries have unwound, European banks have done particularly well.”
The European economy is still struggling at the moment.
As economic activity slows, bank stocks are harder to hit since bank revenues are related to borrowers’ ability to repay loans and fulfill consumers’ and businesses’ appetite for additional credit.
Banks, on the other hand, are better positioned than they were in 2008 to withstand loan defaults.
Authorities proactively established legislation requiring institutions to keep a strong capital buffer against possible losses during the global financial crisis.
Lenders must also have enough cash (or quickly convertible assets) to pay back depositors and other creditors.
Banks have undergone structural changes in the recent decade, according to Luc Plouvier, senior portfolio manager at Dutch asset management firm Van Lanschot Kempen.
“A lot of the regulation that’s been put in place [has] forced these banks to be more liquid, to have much more [of a] capital buffer, to take less risk,” he noted.
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