While European equity prices have been in retreat in recent weeks, the region’s banking stocks are holding up well, bucking the commonly held perception that they are a higher risk trade.
As the Euro Stoxx 600 Banks index closed on Monday still up 11 per cent this year, the question is whether their outperformance versus the broader market can continue. Equity analysts at JPMorgan Cazenove believe it can.
The analysts’ outlook hinges on the trajectory of government bond yields in Europe.
Bank share prices are closely linked to the direction of the 10-year German Bund, with an expectation of higher yields typically bolstering lenders in the eurozone. Yields fell this week in the absence of any guidance from Mario Draghi at Jackson Hole, but the analysts argue that they should take off towards the end of the year as the ECB spells out its schedule for tapering government bond purchases.
JPMorgan has a year-end Bund yield target of 80bp, which the analysts say suggests Eurozone banks will outperform the broader index by 15 per cent. Bunds are currently 33bp.
On top of this expected boost from the Bund, European banks are also starting to see improved earnings. Weak earnings in 2016 have set a low bar for many to clear, while provisioning and non-performing loan levels are down this year.
The analysts note that 75 per cent of the constituents of the eurozone banks index are seeing earnings per share upgrades for 2018.