European banks are a bright spot in the Eurozone

Banks significantly underperformed the European market last year, mainly owing to macro risks stemming from regional politics, trade tensions, sluggish growth and expectations of a persistently low interest rate environment. Within the sector, wealth managers have outperformed, while banks with balance sheet-intensive activities have clearly underperformed.

Banks continue to be hampered by structural problems, as economic growth is decelerating, revenue streams remain subdued given the low interest rate environment, and the cost of funding is set to increase owing to tightening regulatory requirements.

But from a tactical point of view, we think banks could outperform the broader European market this year. Bond yields are stabilizing – aside from recent weakness on concerns over the coronavirus, 10-year bund yields have been on a rising trend since September. The yield curve has steepened modestly and credit quality remains benign, which should continue to support bank earnings. In addition, earnings momentum is improving, albeit from low levels.

The sector is trading at a large (35%) discount to the wider market, which is close to a 20-year low. The valuation discount has been largely driven by the fall in bond yields and the poor profitability of the banking sector.