Posts Tagged ‘ Euro zone ’

Euro zone banks: cheap for a reason

Yesterday my piece for Reuters on Euro zone banks finally hit the wire; you can read it here. A few more thoughts on the sector, which have obviously had a tough time, with first the financial crisis and then the euro zone crisis clearly not being the ideal cocktail for the euro zone’s financial and banking sector…

When any company trades below their accounting value, the market is pricing in some pretty serious tail risk. Draghi’s July speech seems to have removed that tail risk; so what’s holding them back? There’s a whole plethora of issues, including regulation which will jack up capital requirements, as well as the sense that bank’s balance sheets themselves may not tell the whole story, as Neil Dwane says in my article. But there’s also a sense that the rally of the summer has brought prices to a position where by recent standards banks are expensive, despite being below 1 on price to book. There’s a sense that, according to a recent JPMorgan survey, funds are, in terms of recent history, actually overweight; that is to say, because funds have been underweight on banks for so long, that they are now slightly less underweight leaves them holding more banks than at any time in recent history.

The implication is that seeking the usual valuation plays in examining price/book ratios is misplaced, because the risks that remain in the sector are enough to suggest that other stocks or assets just offer better risk-reward returns. Alan Higgins, CIO at Coutts, said he favoured Spanish banking corporate debt, with +10% yields and priority for repayment in worst case scenarios. People like Dwane or Stefan Angele see banks as very unattractive given other sectoral plays to be made.

Being below book is no longer enough to offer a compelling valuation play; the sector has to provide a good news reason why you want to bet on bank growth. That so much of the rally was fuelled by hedge funds closing out shorts on the sector means that, now these hedge fund have finished, investors have to make active decisions that euro zone banks are going to actively outperform other assets on the table. And at this point, not everyone is prepared to make that leap.

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