Daily Management Review

As Earnings Loom Faith In European Banks Being Lost By Trader


As Earnings Loom Faith In European Banks Being Lost By Trader
Investors in European lenders are getting cold feet.
Before posting the second-biggest decline among industry groups this month, riding on a wave of optimism over the economic and earnings outlook, an index of the region’s banks rallied to a 15-month high in March. At the same time, options reached their highest prices since February 2016 relative to those for euro-area blue chips and bets for swings in lenders’ stocks have jumped.
With profits forecast to grow at the fastest pace in three years in 2017 as quicker inflation fuels expectations for monetary tightening, there’s little doubt the environment for European banks has brightened. Yet, especially ahead of an uncertain French election in which far-right candidate Marine Le Pen is campaigning on leaving the euro, higher valuations are now unnerving investors.
“The stocks were too cheap, but the money’s been made from the stocks revaluing to more normal levels,” said James Sym, a London-based fund manager at Schroders Plc, which has trimmed its allocation to the sector while keeping an overweight position. “Everyone has come around to the idea of reflation. I just feel some of these banks have run ahead of themselves.”
Since the election of Donald Trump boosted optimism for greater economic expansion and sent bond yields surging, the Stoxx 600 Banks Index climbed as much as 19 percent.  And up from a record discount, relative to the broader Stoxx Europe 600 Index, that pushed the valuation of European lenders to the highest since October 2015. While the broader gauge was little changed, the Stoxx 600 Banks Index rose 0.5 percent at 8:39 a.m. in London.
according to a Bloomberg Intelligence report led by analyst Jonathan Tyce, lenders will need to be justified by revenue guidance and improvement in interest income and expectations are high as firms including Banco Santander SA and Deutsche Bank AG start reporting first-quarter results next week. Estimates compiled by Bloomberg show that more than the broader market and more than S&P 500 Index banks, lenders in the Stoxx 600 are projected to post 16 percent growth in profits this year.
The single currency would be forced to collapse and lenders would be forced to re-denominate their assets by a Le Pen presidential win which would weigh on the sector as fears of France leaving the euro would escalate. Certain risks should be hedged as their share prices could slump with an adverse political outcome that would drive down revenue for French operations and increase the cost of equity, even though they remain overweight on European banks, Citigroup Inc. analysts said on Wednesday.
As inflation and economic growth quicken, European Central Bank officials have been sending mixed signals on the policy front. Holding hold negative rates well after the end of the year and to run quantitative easing until the end of the year is the current plan. The 10-year German bond yield slumped this month, after jumping to a one-year high in March, helping lenders’ shares.
“The rate at which the environment improves in terms of the yield curve in Europe may have been too optimistic,” said Neil Smith, an analyst at Bankhaus Lampe KG in Dusseldorf, Germany.
Smith added that European investment firms such as Deutsche Bank and Barclays Plc may do better because of strong fixed-income trading revenue in the first quarter at U.S. lenders from Bank of America Corp. to JP Morgan Chase & Co. And according to Bank of America Merrill Lynch reports citing EPFR Global data, despite the recent share weakness, fund flows into the industry have held up in recent weeks.