As Deutsche struggles, European bank rally creates investor dilemma
30/09/2016 15:05
* European banks' performance: http://reut.rs/2cGYHmX
* Deutsche Bank vs peers: http://reut.rs/2du7sPY
* U.S. vs European banks: http://reut.rs/2a27exm
* European banks up 20 percent from July lows
* Traditional banks, Nordics outperform; i-banks struggle
By Alistair Smout
LONDON, Sept 30 (Reuters) - While possibly Europe's biggest
"pain trade", fund managers are under pressure to buy banking
stocks despite the deep problems of Deutsche Bank and some other
lenders in the region.
A 9 percent slump to record lows on Friday for the German
lender was rapidly reversed in afternoon trade, exemplifying the
difficulties investors face in staying bearish on a sector which
still faces fundamental problems.
As the third quarter draws to a close, the main European
banking index .SX7P has rallied 19 percent from the start of
July, with a number of constituent stocks rising sharply in
contrast to those of some German and Italian banks.
This presents a dilemma for fund managers who, following a
long period of poor overall performance by European banking
shares, had taken heavily underweight positions in the sector.
With the index still down around a quarter this year, those
who shifted towards other sectors have outperformed benchmark
indices against which their funds are measured.
But now they find themselves in a tough spot. If the banking
sector keeps rising overall, they risk losing these gains and
underperforming for the full year - unless they raise the
proportion of bank shares in their portfolio at least to
neutral, matching the weightings in the benchmark indices.
According to strategists at Citi, European banks are the
worst performing combination of business sector and geographical
region among the 285 they have tracked over the past decade.
Acknowledging that buying into them now constitutes "the
world's biggest contrarian trade", the analysts led by Jonathan
Stubbs said in a note to clients: "History says Buy, but our key
message is do not Underweight the sector."
GRAPHIC - Deutsche Bank's problems http://tmsnrt.rs/2dcqb49
LONGER-TERM PROBLEMS
Chasing the rally remains risky. The recent slump in shares
of one of the region's largest lenders, Deutsche Bank
DBKGn.DE , in the aftermath of a proposed fine by the U.S.
Department of Justice has underlined the sector's longer-term
problems, especially in the realms of regulation and financing.
urn:newsml:reuters.com:*:nL8N1C61T0
Commerzbank CBKG.DE will cut more than a fifth of its
workforce and suspend its dividend urn:newsml:reuters.com:*:nL8N1C51YF while
uncertainty about the clean-up of bad debts at Italian banks has
also compounded long-standing worries over eroding profitability
and rising regulatory costs.
Swiss investment banks are also struggling with negative
interest rates. Credit Suisse CSGN.S says clients are sitting
on record amounts of cash due to uncertainty in the global
economy, leading to low levels of transactions and fee income.
urn:newsml:reuters.com:*:nL8N1C31Z0 Chief Executive Tidjane Thiam said this week that
banks are generally "a bit difficult to invest in".
Nevertheless, starved of returns and loathe to move into
highly-valued sectors such as healthcare, investors have bought
beaten-down shares - including in banks which suffered the
biggest hits in a selloff that followed Britain's vote to leave
the European Union on June 23.
Since the lows hit on July 6, French bank Natixis CNAT.PA ,
ING Groep ING.AS of the Netherlands and Scandinavian lenders
such Nordea NDA.ST and Sydbank SYDB.CO have all risen more
than 25 percent. In Britain, shares of HSBC HSBA.L and
Barclays BARC.L are also up about a quarter.
The underperformers are dominated by Deutsche, the Swiss
investment banks and a handful of Italian lenders - suggesting
investors are discerning between the weaker and healthier banks
rather than treating the sector as a single trade.
Deutsche's chief executive has told staff that the bank
remains robust despite the demand for up to $14 billion from
U.S. authorities for misselling mortgage-backed securities.
Bankers and policymakers are also playing down comparisons
between the problems at Germany's largest lender and the
collapse of U.S. investment bank Lehman Brothers in 2008 which
sent shockwaves through global markets.
Nevertheless, investors cannot ignore the risk of contagion
and that Deutsche's problems could spread to other banks that
deal with it, should it slide deeper into crisis.
Still, signs of a possible subtle shift in monetary policies
globally away from negative interest rates, prompted by a Bank
of Japan policy overhaul last week, have raised hopes of a
profit recovery for the banks.
This, combined with the multi-year low valuations and fund
managers' heavily underweight positions, suggests there may be
room for the rally to run longer, although many remain cautious.
"I'm not saying that it is now time to buy banks, I'm asking
myself the question about whether it is time to buy banks," said
Guy de Blonay, a portfolio manager specialising in financials at
Jupiter Asset Management.
"I think valuations may be pricing in too much bad news,
because the market was pricing a negative rate getting worse and
worse as we went along," he said.
Blonay's Jupiter Financial Opportunities Fund had only two
banks in the top 10 holdings at the end of August, Banque
Cantonale Vaudoise BCVN.S of Switzerland and Copenhagen-based
Danske Bank DANSKE.CO .
LOCKING IN OUTPERFORMANCE
Fund managers who held a small portion of banks in their
portfolios outperformed as the banking index fell steadily for a
year from July 2015. But the turnaround of the past quarter has
created a problem for those who largely shunned the sector.
"If you did that, you're now at risk of giving back all of
that outperformance," said Edmund Shing, Global Head of Equity &
Derivative Strategy at BNP Paribas.
The solution may be to buy at least some banking stocks.
"At a certain point the pain becomes so great that those who
have lost a bit of their outperformance now want to lock it in,"
he said.
In the Schroder ISF European Equity Alpha fund, for example,
financials rose to just under a third of the portfolio at the
end of August from roughly 26 percent at the end of April.
In a note to clients titled "Are Banks Europe's biggest pain
trade?", Shing said analysts had started upgrading estimates on
banks' return on equity and that the outlook for certain areas
such as retail banking and mortgages is relatively healthier.
While Swiss investment banks like Credit Suisse and UBS
UBSG.S have struggled, lenders focused on more traditional
business such as HSBC, Standard Chartered STAN.L and Swedbank
SWEDa.ST are all comfortably up on the year.
Not everyone is convinced of a turnaround. While profits at
U.S. banks are back above levels last seen before the financial
crisis, those at European banks have halved since 2008.
"It's true valuations are very low. If you have growth, at
some point shareholders will look again at banks but not until
we see a decisive move away from a failed model," said Philipp
Hildebrand, Vice Chairman at fund manager Blackrock.
Hildebrand, who was a Swiss National Bank policymaker during
the global crisis, noted this week that the total return for
bank shareholders since the 1990s had been zero. "That's a
devastating number," he said.
(Additional reporting by Anjuli Davies; Editing by Vikram
Subhedar and David Stamp)
((vikram.subhedar@thomsonreuters.com; +442075426425; Reuters
Messaging: @vikramreuters))
Keywords: BANKS PAIN TRADE/