The longer term outlook for Eurozone banks does look more positive than a year ago given reasons including the substantial deleveraging, capital raising by local banks and the European Central Bank (or ECB)’s recently announced ABS purchase program. However, the European sector’s earning outlook remains a risk to the broader sector in the near term.
That said, these risks are already generally reflected in banking sector valuations.
All in all, I believe the three factors I mention above should support banking sector earnings – and valuations –in the medium term. In fact, I recently upgraded my outlook for the global sector from neutral to overweight.
Market Realist – The graph above shows the balance sheet size of the European Central Bank. It has reduced in 2013. However, a steep rise is expected with the announcement of the ECB purchase program for asset-backed securities.
Market Realist – The graph above shows that U.S. banks (XLF) are more profitable than their European counterparts.
U.S. banks like Citi (C), JP Morgan Chase (JPM), Bank of America (BAC), and Wells Fargo (WFC) have recorded strong returns on equity in 2013. On the other hand, HSBC is one of very few European banks to show stable profitability.
You could attribute the low profitability for European banks to the euro debt crisis and the double-dip recession that followed. Another lagging indicator for European banks is weak corporate lending.
Read our series Must-know: An overview of the banking sector to understand the risks and rewards associated with the sector.