According to JPMorgan, the earnings of European banks will be affected by deteriorating economic conditions and the likelihood that interest rates have reached their peak. They recommend selling short in this sector.
The Good Run and Outperformance of European Banks
Mislav Matejka, JPMorgan’s head of global and European equity strategy, published research highlighting the strong performance of the continent’s banking sector. So far in 2023, it has gained 8%, compared to the STOXX 600’s 1% advance. Since September 2020, the sector has even outperformed by 60%.
The Right Time to Go Underweight in European Banks
Now that most banks have released their third-quarter earnings, JPMorgan suggests going underweight in the sector. Matejka states, “We are advising to open a short in European banks.”
Reasons for the Downgrade
JPMorgan provides several reasons for this downgrade. Firstly, they predict that bond yields will reach their peak this quarter, causing bank earnings to struggle due to a contraction in net interest income.
The sharp increase in bond yields over the past three years played a significant role in the banks’ rally. For example, German 10-year BX:TMBMKDE-10Y went from -0.5% to 3%, and U.S. 10-year BX:TMUBMUSD10Y went from 1% to 5%. Any decrease in yields or potential cuts by the European Central Bank (ECB) next year will decrease banks’ profitability.
Additionally, other monetary factors such as the unwinding of ECB support programs for the sector, alongside quantitative tightening by central banks and a potential increase in reserve requirements, could create headwinds.
JPMorgan also mentions regulatory concerns for the sector. Recent favorable conditions, including share buybacks and capital return to shareholders, may not continue. Moreover, there is an elevated risk of punitive taxes being discussed in several countries.
In conclusion, JPMorgan advises investors to take a cautious approach to European banks due to the impact of deteriorating economic conditions, peaked interest rates, and potential regulatory changes.
JPMorgan’s Perspective on Banks
JPMorgan recently highlighted the vulnerability of banks due to their high leverage and their dependence on overall economic activity. In the event of an economic downturn or changes in credit conditions, banks could face considerable challenges such as widening spreads and an increase in delinquencies.
However, this note from JPMorgan did not have a significant impact on European bank shares. Despite this warning, the STOXX 600 Bank index saw a 0.3% increase on Monday, even as the largest member, HSBC, experienced a slight dip.
HSBC, listed on the UK stock exchange, showcased its resilience in the face of economic challenges. Despite delivering third-quarter results that included a $500 million provision for commercial property in China, the bank remained largely unaffected. Its ability to weather economic storms can be attributed to its sheer size and strategic business growth, particularly in areas where it has a competitive advantage.
Moreover, HSBC announced an additional $3 billion in share buybacks, which further strengthens market confidence. Analysts have recognized the bank’s strong performance, considering its recent outperformance in the share price.
Positive Outlook for Markets
The wider market displayed a positive outlook, with futures pointing to a favorable session on Wall Street. The DAX in Frankfurt rose 0.6%, the CAC 40 in Paris added 0.7%, and London’s FTSE 100 gained 0.8%.
Currency and Bond Market Fluctuations
The value of the UK pound remained steady, just slightly above seven-month lows. Meanwhile, the 2-year gilt yield experienced a 4.8 basis points increase to 4.797%, as traders anticipate the Bank of England’s upcoming monetary policy meeting. It is widely speculated that the interest rates will remain unchanged at 5.25%.