Bank stocks – Experts estimate that major economies will either slow down or fall into a recession.
As a result, investors today are abandoning tradition in 2023, piling into major bank stocks.
Between January and late February, the Stoxx Europe 600 Banks index, consisting of 42 major European banks, climbed by 21%.
It hit a five-year high, outperforming the Euro Stoxx 600, its broader benchmark index.
Meanwhile, the KBW Bank tracks 24 of the leading US banks, and it rose by 4% in 2023, slightly outpacing the broader S&P 500.
Following the lows last fall, the two bank-specific indexes have surged.
However, the economic picture is less encouraging.
The United States and the European Union’s biggest economies are projected to grow sluggishly compared to last year.
Meanwhile, the UK output is expected to decrease.
According to former Treasury Secretary Larry Summers, a sudden recession at some point is risky for the United States.
However, central banks were forced to raise interest rates following the widespread economic weakness coinciding with high inflation.
Regardless, it has been a bonus for banks, allowing them to make larger returns on loans to households and businesses as savers deposit more money into their savings accounts.
While rate hikes have anchored big banks’ stocks, fund managers and analysts said that great confidence in their ability to endure economic storms after the 2008 global financial crisis has also played a role.
“Banks are, generally speaking, much stronger, more resilient, more capable to [withstand] a recession than in the past,” said Roberto Frazzitta, the global head of banking at Bain & Company.
Interest rate increases
Last year, policymakers launched campaigns against the increasing inflation as interest rates in major economies increased.
The steep hikes followed a period of low borrowing costs that began in 2008.
The financial crisis ruined economics, prompting central banks to slash interest rates lows to incentivize spending and investment.
For more than a decade, central banks barely budged.
Investors don’t typically bet on banks in an environment where lower interest rates typically feed into lower lender returns.
Thomas Matthews, a senior markets economist at Capital Economics, said:
“[The] post-crisis period of very low interest rates was seen as very bad for bank profitability, it squeezed their margins.”
However, the rate hiking cycle from 2022, coupled with a few signs of easing up, changed investors’ calculations.
On Tuesday, Fed Chair Jerome Powell said interest rates would rise higher than anticipated.
Due to the higher potential shareholders’ returns, investors have been drawn back.
For example, Ciaran Callaghan, the head of European equity research at Amundi, said the average dividend yield for European bank stocks is currently at around 7%.
According to Refinitiv data, S&P 500’s dividend yield currently stands at 2.1% while Euro Stoxx 600 is 3.3%.
Additionally, European bank stocks rose sharply in the past six months.
Thomas Matthews attributed Capital Economics’ outperformance to US peers based on how interest rates in the countries using euros are closer to zero than in the United States, which means investors have more to gain from the increasing rates.
He also noted that it could be due to Europe’s remarkable reversal of fortune.
Wholesale natural gas prices in the region hit a record high last August, but they have since tumbled to levels prior to the Ukraine war.
“Only a few months ago, people were talking about a very deep recession in Europe compared to the US,” said Matthrew.
“As those worries have unwound, European banks have done particularly well.”
Right now, European economies are still weak.
Whenever economic activity slows, bank stocks are challenging targets to hit due to banks’ earnings ties to borrowers’ ability to repay loans and satisfy consumers’ and businesses’ appetite for more credit.
However, unlike in 2008, banks are better positioned to endure loan defaults.
Following the global financial crisis, regulators proactively set up measures, requiring lenders to have a sizable capital cushion against future losses.
Lenders must also have enough cash (or assets that can be quickly converted) to repay depositors and other creditors.
Luc Plouvier, a senior portfolio manager at Dutch wealth management firm Van Lanschot Kempen, noted that banks underwent structural changes in the past decade.
“A lot of the regulation that’s been put in place [has] forced these banks to be more liquid, to have much more [of a] capital buffer, to take less risk,” he noted.