And poof, it’s gone! First Republic Bank’s magical disappearing trick wowed us all on Monday. Other US regional lenders seem to be practising the same. My European bank ETF better not vanish in a puff of smoke. I won’t clap.
Time to take profits, then? Answering this requires number crunching. And some thought. Which would be more than I did before purchasing the fund six weeks ago, if I’m honest. A bit of a rush job, it was.
Perhaps that’s not entirely fair. I said I liked banks back in January, explaining how they were cheap relative to most global sectors. But it was the sell-off on March 24 that made me push the button. I cannot resist the smell of fear.
European banks were preferable because their shares were in free fall. Credit Suisse had just gone splat. The word “contagious” was spreading. Germany’s chancellor said: “There is no reason to be concerned.” Scary stuff indeed.
Still, even with the likes of Deutsche Bank down 14 per cent that day, it felt to me more like a post-Silicon Valley Bank wobble than an earthquake. Thus it has proved — so far. My Amundi fund is up 8 per cent in a month and a half.
That’s a nice return. But one cannot ignore the US’s second-biggest bank failure. I’m not going to prove I’m a long-run investor for the hell of it. My ETF is down almost 3 per cent in a week. Do the potential returns of owning European bank stocks still outweigh the risks?
Step one when analysing a fund is to look at the biggest holdings. It’s easier to aggregate the financials of 10 companies than hundreds, but we need to be sure they are representative. And might a large weighting skew our analysis?
The top 10 names represent 70 per cent of the value of Amundi’s European bank ETF. That’s good enough for me. We need to keep an eye on HSBC, though. With a 17 per cent weighting, it is twice the size of second place BNP Paribas.
Step two is valuation. For portfolio managers with relative benchmarks, they care if banks are cheap or expensive versus a broader index or other sectors. But I’m running my own money. Only absolute performance matters.
Therefore I focus on the fund’s valuation relative to history. Is it higher than when I bought it, and how about compared with the long run? By my calculations, the forward price/earnings ratio for the top 10 banks has notched up only 30 basis points since I bought them, to 6.7 times.
That’s still cheap as chips versus the past 10 years too — less than half price using historic earnings as a guide. So no worries there — especially as aggregate consensus earnings per share growth for the next year is 13 per cent.
Likewise, Europe’s biggest lenders are trading on a market cap-weighted average of 0.6 times book value. In other words, in theory at least, you could buy all 10 for half a trillion pounds, shut them down, sell their assets, and make more than 50 per cent on your money.
This is also in line with when I bought the ETF and remains well below the decade average of 0.8 times. I am weary of book ratios for banks, however. As this latest mini crisis reminds us once more, trusting the reported asset values on bank balance sheets is foolhardy. Perhaps a 40 per cent discount makes sense.
Let’s recap then. We have an ETF of European banks that rose 40 per cent from last April to late February, mostly due to higher interest rates boosting net interest margins. The sector then took a tumble in the wake of Silicon Valley Bank and Credit Suisse, at which point I pounced. Following a strong rebound, prices have been heading south for the past fortnight.
But the fund is still cheap on an earnings basis in absolute terms and relative to history. Meanwhile, profits are well supported, as the latest quarterly results have shown. The same can be said for prices versus book values, but we need to treat the latter with scepticism.
These discounts exist for a reason, of course. Banks are leveraged up the wazoo but barely earn their cost of capital, making them risky investments. And a reliance on legacy platforms and relationships means they aren’t the best at anything they do any more. No wonder European lenders have trailed the broader market by 125 per cent over the past quarter of a century.
That said, fintechs and crypto-warriors are dreaming if they think traditional lenders will be extinct any time soon. Both retail and institutional clients are creatures of habit. Banks have powerful friends, too. I once worked for a chief executive of a megabank and politicians the world over were constantly beating on his door.
No, this is a sector to trade over the short and medium term only. Trouble is, even then it hardly seems worth the effort. During the three periods when equities were mostly falling over the past 10 years, banks underperformed the Euro Stoxx by 7 percentage points on average. When equities were generally rising, banks trailed by 12 per cent.
My inclination, therefore, is to take my winnings, celebrate being one of the few shareholders to make money out of European banks, and head to the pub (my default solution, as you’re beginning to learn). I’ll try to finesse my exit — it’d be cool to be back in double figures again.
If that doesn’t happen soon, however, and more regional lenders in the US start disappearing, I’ll pull my European bank ETF off the stage myself. And I won’t be gentle about it.
The author is a former portfolio manager. Email: stuart.kirk@ft.com; Twitter: @stuartkirk__
