At the start of 2018, many analysts we spoke to were positive about European cyclicals, especially financials, after what was a bumper fourth quarter for the continents economic data.
With a strong beta to underlying growth, as well as relatively cheap valuations to US counterparts, what was not to love? It seems quite a lot.
The long financials play has unfortunately not worked out the way many had been hoping for. The sector is one of the worst performing in Europe this year, down more than nine per cent.
No doubt a good part of that is due to positioning in the space, that also happened to coincide with a slowdown in economic data and renewed dovishness out of the European Central Bank. This has since dispelled any hopes of rate hikes for at least another 12 months, which in turn serves as a headwind for the banking sector.
In the past three months, investors have pulled cash away from the continent, first due to political concerns, such as in Italy and Germany, and then trade concerns, such as tariffs.
Interestingly, banks have been the hardest hit – even more so than the automotive industry. But has the time come to dip toes back in again?
We are about midway through the European earnings season. According to Deutsche Bank research, the best earning per share growth surprises so far have been exhibited by financials, with analysts expecting even further earnings growth in the third quarter.
The average price-to-book among European banks is just shy of one (anything under one is usually considered good value), compared to around 1.6 for US equivalents. So, from a valuation standpoint, the temptation is there.
Ali Miremadi, investment director at GAM, recently told CNBC that in todays environment, its less about the macro and more about picking the banks with the right strategy and the ability to deliver on cost-cutting measures.
He cited Unicredit as being one bank that has managed to increase revenue, cut costs, and maintain its capital position – yet is still very undervalued.
Almost every chief executive I have interviewed in the last couple of quarters has emphasised this point: the number one priority is bringing down costs, and investors are quick to punish those who are not delivering quickly enough.
Sceptics also point to ongoing extra capacity in the space and much-needed consolidation.
We are already beginning to see activity there, both in cross-border – with Commerzbank selling part of its equities business to Societe Generale – and domestically, with Spanish banking consolidation being a good example.
On redefining strategy, no segment exemplifies the shift in thinking better than Swiss banks, which – after a long experiment with the more volatile investment banking and capital markets business – have collectively refocused back into private banking.
The results are paying off, particularly as these banks push into Asia.
The objective has shifted away from high return on an equity to a “stable and steady” fee-generating model. Or, as Miremadi summarised, “regulators have achieved their aim of making European banks boring”.
After years of negative surprises, perhaps its time to make boring great again.