And poof, it’s gone! First Republic Bank is magical disappearing makeup wowed us all on Monday. Other US regional lenders appear to practice the same. My European bank ETF better not vanish in a puff of smoke. I will not clap.
Time to take profits then? Answering this requires number crunching. And some thoughts. That would be more than I did before I bought the fund six weeks ago, if I’m being honest. It was a bit of an urgent job.
Maybe that’s not quite right. I said I liked banks in January, explaining how cheap they were compared to most global sectors. But it was the March 24 clearance sale that made me push the button. I can’t 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. The German chancellor said: “There is no reason to worry.” She really scary stuff.
However, even with stocks like Deutsche Bank down 14% that day, it felt more like a post-The Bank of Silicon Valley falters what an earthquake. So she has proven-so far. My Amundi fund has grown by 8% in a month and a half.
It’s a nice comeback. But one cannot ignore the second largest bank failure in the United States. I’m not going to prove I’m a long-term investor for the sake of it. My ETF is down nearly 3% in one week. Do the potential returns from owning European bank shares still outweigh the risks?
The first step when analyzing a fund is to look at the largest holdings. It’s easier to aggregate the financials of 10 companies than hundreds, but we need to make sure they’re representative. And could a large weighting distort our analysis?
The top 10 names represent 70% of the value of Amundi’s European bank ETF. This is good enough for me. We have to keep an eye on HSBC, though. With a weighting of 17%, it is double the second place of BNP Paribas.
The second step is evaluation. For relative benchmark portfolio managers, they care about whether banks are cheap or expensive relative to a broader index or other sectors. But I’m managing my money. Only absolute performance matters.
Therefore I focus on evaluating the fund versus the story. Is it higher than when I bought it, and how about over the long haul? By my calculations, the forward price-earnings ratios for the top 10 banks have increased by just 30 basis points since I bought them, to 6.7x.
It’s still cheap as a chip over the past 10 years, less than half the price using historical earnings as a guide. So don’t worry, especially since aggregate earnings per share growth for next year is 13%.
Similarly, the largest European lenders trade on a market capitalization weighted average of 0.6 times book value. In other words, at least in theory, you could buy all 10 of them for half a trillion pounds, close them, sell their assets and make more than 50% of your money.
This is also in line with when I bought the ETF and remains well below the 0.8x 10-year average. However, I’m wary of accounting reports for banks. As this latest mini-crisis reminds us yet again, trusting the asset values reported on banks’ balance sheets is ill-advised. Maybe a 40% discount makes sense.
Let’s recap then. We have a European Bank ETF that is up 40% from last April to the end of February, mainly due to higher interest rates which have increased net interest margins. The sector then suffered a slump in the wake of Silicon Valley Bank and Credit Suisse, at which point I pounced. After a strong rebound, prices have fallen over the past two weeks.
But the fund is still cheap based on absolute and historical relative earnings. Meanwhile, earnings are well supported, as the latest quarterly results have shown. The same can be said for prices versus book values, but we must treat the latter with skepticism.
These discounts exist for a reason, of course. Banks are stretched to the max but barely earning their cost of capital, making them risky investments. And relying on legacy platforms and relationships means they’re no longer the best at whatever they do. No wonder European lenders have lost the broader market by 125% over the last quarter century.
That said, fintechs and crypto-warriors are dreaming if they think traditional lenders are going to die out soon. Both retail and institutional clients are creatures of habit. Even the banks have powerful friends. I once worked for the CEO of a megabank and politicians from all over the world were constantly knocking on his door.
No, this is a sector that should only be traded in the short to medium term. The problem is that even then it doesn’t seem to be worth it. During the three periods that equities have been mostly down over the past 10 years, banks have underperformed the Euro Stoxx by an average of 7 percentage points. When stocks were generally up, banks were down 12%.
My inclination, then, is to take my winnings, celebrate being one of the few shareholders making money with European banks, and hit the pub (my default fix, as you’re starting to learn). I will try to perfect my exit – it would be nice to be back in double figures again.
If that doesn’t happen soon, however, and other regional lenders in the US start to disappear, I will pull my European bank ETF off the stage myself. And I won’t be kind.
The author is a former portfolio manager. E-mail: stuart.kirk@ft.com; Chirping: @stuartkirk__
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