The European banking sector has successfully navigated the recent earnings season, promising large-scale stock buybacks that have fueled a remarkable rally, marking the best consecutive gains since 1997. For nine weeks straight, bank stocks have seen an upswing, emerging as the leading sector in this year’s European market, with an impressive increase of 18%. Contrary to expectations, the decline in interest rates did not adversely affect the banking industry; instead, economic resilience and vast stock repurchase plans have further contributed to this price appreciation.
Roberto Schorltz, the chief strategist at SingularBank, emphasized the solid foundation for the banking industry’s leadership in stock market gains. He pointed out that banks’ earnings for the fourth quarter have surpassed expectations by approximately 10%. “Looking ahead, these positive trends are likely to continue,” he added, signaling a bright outlook for the sector amid broader market dynamics.
The ascent of the banking industry began at the end of 2020 and has gained momentum just as expectations heightened ahead of the earnings reports. Since then, the Stoxx 600 Banking Index has more than doubled. While some banks have experienced declines in performance due to rising costs and concurrent income, investors have quickly seized the opportunity to buy at lower prices. For instance, both Unicredit of Italy and Barclays showed significant recovery following recent declines in their stock prices after earnings announcements.
Jason Napier, an analyst at UBS Group leading a team that maintains a bullish rating for the sector, stated, “On the whole, all banks have exceeded profit expectations. A remarkable 89% of banks reported profits before provisions that were above forecasts, and 79% had pre-tax profits that also exceeded predictions.” The team suggested that a rise in revenue accompanied by higher costs is not surprising given the current market environment.
Investor confidence remains strong regarding further upside potential. According to a recent survey by Bank of America, bank stocks have become the most heavily weighted segment in Europe’s market since July 2023, with investors viewing them as one of the most undervalued sectors currently available. Financial stocks, more generally, are anticipated to rank among this year’s best-performing sectors.
The announcements of stock buyback plans during the earnings season have provided the market with robust momentum. Since the start of the year, financial institutions have made significant contributions to announced repurchase programs. Following the expected trend, banks are projected to once again become major contributors to shareholder returns after making up nearly one-fifth of the total dividends and buybacks for the Stoxx 600 constituents in 2024.
The rally has prompted a re-evaluation of bank stocks, which are now seen in a less undervalued light than before. The expected price-to-book ratio for the Stoxx 600 Banking Index is approaching a 15-year high, while the expected price-to-earnings ratio has reached its highest point in two years, indicating a significant shift in investor sentiment.
Andrew Stimson, an analyst with Keefe Bruyette & Woods, pointed out, “Over the past 25 years, it has often been the case that when bank stock valuations reach extreme levels, their stellar performance begins to wane.” He specifically noted that a price-to-earnings ratio of 10 and a relative P/E ratio of 80% represent valuation ceilings, suggesting a further upside potential of around 30% from current levels compared to historical trends.
While the team maintains a favorable outlook for bank stocks, they also caution that “market performance is rarely a straight line.” To anticipate the next stage of this rally, one must consider the need for reduced cost of stocks and affirm faith in light growth in the region.
Despite the relative absence of pessimism towards the banking industry, strategists at JPMorgan hold a cautious view, suggesting an underweight stance on bank stocks. They raise concerns over potential profit peaks and the risks associated with central bank rate cuts.
The current global economic landscape is notably complex and fluid, capturing the attention of analysts and investors alike. Projections indicate that the Eurozone's growth rate is expected to reach 0.9% by 2025, signifying steady progress in its recovery journey. Nonetheless, a variety of uncertainties continue to loom over the economic environment. It is anticipated that the European Central Bank (ECB) will implement three additional interest rate cuts this year, a move intended to stimulate the economy but which could also affect bank profitability. Historically, the ECB has exercised caution in balancing economic stimulus with financial stability, seeking the optimal path forward. Concurrently, a steepening yield curve in bonds bodes well for the banking sector, signaling positive shifts in market liquidity and investment outlooks that promise a more favorable environment for banking operations.
Emmanuel Caouette, a strategist at Barclays leading his team, remarked, “Banks can particularly reflect shifts in macroeconomic and profitability conditions, showcasing how self-help measures such as stock buybacks can enhance profitability and thus inflate valuations.” He further added, “There's still considerable room for improvement in the valuation of banks.”