Macaskill on markets: Bank shares and the Charlie Brown trap

COPYING AND DISTRIBUTING ARE PROHIBITED WITHOUT PERMISSION OF THE PUBLISHER: SContreras@Euromoney.com

By:
Jon Macaskill
Published on:

Bank shares have bounced back from recent lows in early 2019, but investors tempted to bet on a sustained rally risk yet another year of disappointment.

Sewing football_780


The Peanuts comic strip features a recurring gag where Charlie Brown is convinced to run up and kick a football, only for Lucy to pull the ball away at the last moment. Investors tempted to take a punt on a recovery in bank share prices can be forgiven for worrying that a bet on a prolonged rise in values will prove to be a similar triumph of hope over experience.

A global slump in bank stocks in December was followed in January by poor quarterly trading results from most firms, while a partial US government shutdown prevented the SEC from approving IPO paperwork, ensuring that the year in deal making got off to a slow start.

Bank stocks have nevertheless performed strongly, leading analysts and investors to wonder if 2019 will be a year of recovery, despite the formidable array of risks on the horizon. The KBW Nasdaq index of US bank stocks was up by around 14% for the year by late January, while the comparable Euro Stoxx bank index was up by 8%.

The European index was still down by almost 30% on a trailing 52-week basis, however, and many of the bigger banks from the region trade at levels well below the nominal value of their assets.

That presents a theoretical potential for a good appreciation in price, although existing owners of European bank shares – including employees who are saddled with unavoidable exposure to their own firms from bonuses – tend to alternate between gloom and outright despair when they contemplate the prospects for a meaningful recovery.

There are opportunities but also possible pitfalls for agnostic investors who can choose how they take exposure to the sector.

Idiosyncratic risk is one lurking value trap. 

Strong contender

Deutsche Bank might look like a contender for a bounce, for example, given that it trades at the biggest discount to its nominal assets of any of the big banks, with investors apparently taking the view that it is currently worth little more than a quarter of the value reported by its management.

Deutsche is also a strong candidate for a merger if and when consolidation of the biggest firms in the region finally gets underway. And it is unlikely that a German government would allow a complete failure of the bank, which was traditionally viewed as a national champion.

But Deutsche also has reputational issues that are unlike those faced by any other peer firm – even banks such as Goldman Sachs that have some big and unresolved regulatory and legal challenges.

It wouldn’t be a new year without some fresh investigation of possible misconduct at Deutsche, and the firm already faces probes into its involvement in Den Danske’s €200 billion Russian money-laundering scandal, along with the prospect of US congressional hearings on its actions as a banker to president Trump.

Deutsche also faces an existential threat to a business model that remains dependent on sales and trading revenues from its investment bank. It has lost a lot of market share in both fixed income and equity trading, and chief executive Christian Sewing’s efforts to control costs will have little long-term impact if sustainable revenue growth cannot also be achieved. 


Analysts do not expect much growth in 2019 or 2020, so market share will remain a key barometer of success in the near term 

The global investment banking revenue pool has not seen any meaningful change in recent years – hovering at around $150 billion a year for the top banks, despite shifts in the relative performance of different sub-sectors.

Analysts do not expect much growth in 2019 or 2020, so market share will remain a key barometer of success in the near term.

Barclays has joined Deutsche in suffering from stock weakness in recent years, but it is a rare example of a European bank that has managed to claw back some lost investment banking market share. 

It faces other challenges, however, such as a developing campaign by activist investor Edward Bramson to force a pullback from the current strategy of increasing investment bank risk limits in pursuit of market share.

A shift from that strategy would almost certainly involve the departure of Barclays’ chief executive, Jes Staley, and his investment bank head, Tim Throsby, which would increase the near-term volatility of its stock price, even if it had a beneficial long-term impact. 

So if investments in individual beaten-down bank shares necessarily have too much idiosyncratic risk, what is the best way to profit from a possible return to historical valuations relative to assets?

Exposure to an index of bank shares is an obvious option. The Euro Stoxx bank index known as SX7P, which comprises 48 banks, currently has more than a third of its exposure to three large European firms: HSBC, Santander and BNP Paribas.

That seems to offer a degree of security, along with gearing to a potential recovery for the sector. But it is worth recalling that as recently as five years ago the index had a lot of exposure to three banks that have since seen a collapse in their value, in the form of Deutsche, Barclays and Standard Chartered.

And HSBC, Santander and BNPP have all had their own regulatory and reputational challenges, even if their balance-sheet strength allowed them to manage the impact of fines and stress test failures. 

Relative value trades within the banking sector are an alternative way to bet on changes in fortune among firms.

Potential wager

One potential wager is a bet on a reversal in the relationship between US and European banks. The current narrative consensus that US banks are steadily squeezing their European rivals out of any market with a meaningful upside is reflected in both stock and credit prices.

So a long/short bet on the Euro Stoxx SX7P versus the KBW Nasdaq bank index might appeal as a prediction that European firms will recover some ground.

This view could also be expressed by selling credit default swap protection on a basket of European banks while buying protection on US banks.

There are other areas of potential upside in niche corners of the market for bank debt. The market for European bank capital bonds that have equity-like characteristics could receive a boost from the recent Chinese move to allow dealers to swap bank-issued perpetual debt for liquid central bank bills, for example.

The Chinese move is aimed at bolstering its own banks, but if it pushes down yields on local bank debt, that in turn could prompt Asian investors to buy higher-yielding instruments from European banks, especially firms with brand appeal in Asia, such as HSBC and Standard Chartered.

But finely calibrated trades on a recovery in banking sector share valuations still face a fundamental Charlie Brown-style trap – the demonstrated ability of the executives who run banks to sabotage their own fortunes.