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Deteriorating economic conditions with the likelihood that interest rates have peaked will impact the earnings of European banks, and the sector should be sold short, said JPMorgan.
In research published Monday, Mislav Matejka, JPMorgan’s head of global and European equity strategy, noted that the continent’s banking sector has had a good run in 2023, gaining 8% so far against the STOXX 600’s 1% advance. Indeed the sector has outperformed by 60% since September 2020.
But now that most banks have released third-quarter earnings, it is a good time to go underweight the sector. “We are advising to open a short in European banks,” he said.
A number of reasons were given for the downgrade. First, JPMorgan reckons that bond yields will peak this quarter and that will cause bank earnings to struggle as net interest income contracts.
“After all, the banks rally was underpinned by the sharp move up in bond yields over the past three years, with German 10 year
BX:TMBMKDE-10Y
moving from -0.5% to 3%, and U.S. 10 year
BX:TMUBMUSD10Y
from 1% to 5%. Any potential fall in yields, or the ECB cuts next year, will reduce banks’ profitability,” wrote Matejka.
In addition, other monetary issues — such as the unwinding of ECB support programs to the sector, alongside the central banks quantitative tightening and a potential increase in reserve requirements — could cause headwinds.
“From the regulatory side, the sector might not enjoy as favorable a backdrop as it did recently, with buybacks and capital return to shareholders as good as they get. Also, the risk of punitive taxes is elevated – it is being discussed in a number of countries,” JPMorgan added.
Finally, JPMorgan said that with banks much more levered than any other sector they are “a beta play on overall activity. Banks could suffer if economies enter contraction, and if some of the very benign credit backdrop changes next year, with spreads widening and delinquencies rising.”
Source: JPMorgan
The JPMorgan note did not seem to have a great impact on European bank shares on Monday, however, with the STOXX 600 Bank index
XX:SX7P
up 0.3% despite the biggest member HSBC dipping on the day.
U.K.-listed HSBC
HSBA,
-0.50%
gave up early gains to trade off 0.3% after delivering third quarter results that included a $500 million provision related to commercial property in China, and despite announcing a further $3 billion in share buybacks.
“HSBC is managing to shield itself from economic attack through its sheer size, while also remaining mindful on the importance of continuing to grow the business, especially in areas where it has particular strength,” said Richard Hunter, head of markets at Interactive Investor.
“The announcement of a further share buyback leaves little for detractors to focus on, despite a couple of minor misses. Although the recovery of the Chinese economy is currently faltering, prospects remain many and varied for HSBC, which is part of the reason for the recent outperformance of the share price, Hunter added.
The wider market was more upbeat as futures pointed to a positive session later on Wall Street. The DAX
DX:DAX
in Frankfurt rose 0.6%, the CAC 40
FR:PX1
in Paris added 0.7% and London’s FTSE 100
UK:UKX
gained 0.8%.
The U.K. pound
GBPUSD,
+0.08%
hovered less than a cent above seven-month lows and the 2-year gilt yield
BX:TMBMKGB-02Y
added 4.8 basis points to 4.797% as traders jostled ahead of the Bank of England’s monetary policy meeting on Thursday, after which it is expected to leave interest rates unchanged at 5.25%.
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