# Analysis-Banks lag bond yield surge as recession worries trump cheap valuations
Author:  Pal Sinha, Barnali 
Author URL: https://financedigest.com/author/pal-sinha-barnali
Published: 2022-04-28
Category: FINANCE
Category URL: https://financedigest.com/category/finance
Meta Title: Why European Bank Shares Fail to Benefit from Rising
Meta Description: European bank shares are at near two-decade lows despite rising interest rates, with growth concerns overshadowing potential gains from increasing bond yields.
URL: https://financedigest.com/analysis-banks-lag-bond-yield-surge-as-recession-worries-trump-cheap-valuationshtml

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By Danilo Masoni

MILAN (Reuters) – Expectations of rising interest rates have failed to lift valuations of European bank shares languishing at near two-decade lows as a worsening growth outlook weighs on the broader finance industry.

Rising bond yields are a boon for banks as they tend to boost interest income but the strongest two-month jump in borrowing costs seen across the euro zone since 1994 has not translated into stock market outperformance for banks.

A gauge of European [bank stocks has shed 6% since the start of March and is not far from 14-month lows hit last month as the war in Ukraine has raised prospects of dragging the region into recession](https://www.financedigest.com/banking-turmoil-means-recession-fears-are-creeping-back.html "Banking turmoil means recession fears are creeping back").

That underperformance has also opened up a huge gap with the historically high positive correlation with [bond yields](https://www.financedigest.com/stocks-up-bond-yields-fall-as-markets-mull-a-fed-policy-pause.html "Stocks up, bond yields fall as markets mull a Fed policy pause"), a sign there could be scope for a bounce. A 90-day correlation between MSCI Europe Banks and 10-year German [bond yields](https://www.financedigest.com/global-equities-gain-as-rising-bond-yields-pressure-gold.html "Global equities gain, as rising bond yields pressure gold") is at its lowest in over nine years, based on Refintiv data.

U.S. banks have also seen a similar trend, despite the surge in [Treasury yields](https://www.financedigest.com/wall-st-flutters-treasury-yields-ease-as-powell-resumes-testimony.html "Wall St flutters, Treasury yields ease as Powell resumes testimony"), though to a lesser extent.

![European bank stocks and yields](https://www.globalbankingandfinance.com/wp-content/uploads/2022/04/109-1-747x500.jpg)

Graphic: European bank [stocks and yields](https://www.financedigest.com/stocks-fall-treasury-yields-rise-upon-final-2022-trading-day.html "Stocks fall, Treasury yields rise upon final 2022 trading day") – https://fingfx.thomsonreuters.com/gfx/mkt/klpyklqerpg/Banks%20and%20yields.PNG

This is currently one of the [big topics among investors and it’s keeping us busy](https://www.financedigest.com/smishing-is-a-new-virus-plaguing-big-business-conversational-commerce-to-the-rescue.html "‘Smishing’ is a new ‘virus’ plaguing big business – Conversational Commerce to the rescue!"). The correlation used to work very well in the past and the fact it’s broken now can’t be fully explained by macro or geopolitical factors,” said Jerome Legras, head of research at Axiom [Alternative Investment](https://www.financedigest.com/investing-in-the-future-with-alternative-web-data.html "Investing in the future with alternative web data") in London.

Even if they have recovered from the 2020 pandemic lows, [European banks](https://www.financedigest.com/token-inc-launches-london-office-to-answer-demand-from-european-banks.html "Token, Inc. Launches London Office to Answer Demand from European Banks") currently trade almost 40% below than their 18-year average valuation, based on a price to book metric, as per Refinitiv data. They trade at 0.3 times the broader market, which is also a nearly 40% discount to the 18-year average.

The only thing that would justify these levels would be if we were [heading towards a recession](https://www.financedigest.com/euro-zone-october-pmi-adds-to-evidence-bloc-is-heading-for-recession.html "Euro zone October PMI adds to evidence bloc is heading for recession"). That’s what the [shares are pricing](https://www.financedigest.com/netflix-cuts-prices-in-some-countries-to-boost-subscriptions-shares-drop.html "Netflix cuts prices in some countries to boost subscriptions, shares drop") but at the moment, no economist, no other indicators are,” he added.

UBS has just landed its best [profit in 15 years and Deutsche Bank extended its longest profit streak since](https://www.financedigest.com/apples-weak-iphone-sales-drive-first-profit-miss-since-2016.html "Apple’s weak iPhone sales drive first profit miss since 2016") 2012, although geopolitical and macro uncertainties cloud the outlook.

The concern is that [surging commodity prices](https://www.financedigest.com/explainer-oil-price-surge-changes-ecb-narrative-only-at-the-margins.html "Explainer-Oil price surge changes ECB narrative only at the margins") and rising rates could lead to slower economic activity, reducing deal volumes and fees for banks, while headwinds grow as a consequence of businesses struggling to pay back debt.

![European banks valuation](https://www.globalbankingandfinance.com/wp-content/uploads/2022/04/108-747x500.jpg)

Graphic: [European banks](https://www.financedigest.com/more-banks-join-european-instant-payments-pilot-from-end-2023.html "More banks join European instant payments pilot from end 2023") valuation – https://fingfx.thomsonreuters.com/gfx/mkt/zdpxogaowvx/European%20banks%20valuation.PNG

NOT ENOUGH

Against this backdrop, Generali Investments, which has around 583 [billion euros](https://www.financedigest.com/delivery-hero-ramps-up-interest-payments-to-raise-1-billion-euro-convertible-bond.html "Delivery Hero ramps up interest payments to raise 1 billion euro convertible bond") ($613 billion) of assets under management, recommends maintaining a neutral allocation on banks, even though valuations look attractive.

Usually banks need three legs to perform: [higher yields](https://www.financedigest.com/wall-st-indexes-mixed-treasury-yields-tick-up-as-higher-rates-loom.html "Wall St indexes mixed, Treasury yields tick up as higher rates loom"), moderate credit spreads and increasing GDP growth. Of the three, only rates are supportive at the moment,” said Michele Morganti, [senior strategist at the Italian asset manager](https://www.financedigest.com/senior-managers-regime-what-does-it-mean-for-the-industry.html "SENIOR MANAGERS REGIME – WHAT DOES IT MEAN FOR THE INDUSTRY?").

A London-based [hedge fund](https://www.financedigest.com/what-is-a-hedge-fund.html "What Is A Hedge Fund") trader estimates a 20 basis points increase in the cost of risk would erode the benefits of a 100 point move in interest rates.

The [ECB is expected](https://www.financedigest.com/hawkish-ecb-comments-push-up-rate-hike-expectations.html "Hawkish ECB comments push up rate-hike expectations") to raise interest rates by 80 bps by end-2022 but policymakers are cautious. The Bank of Spain [warned](https://www.financedigest.com/the-recent-bank-of-england-meeting-the-biggest-rate-hike-recession-warning-and-the-fallout.html "The recent Bank of England meeting, the biggest rate hike, recession warning and the fallout") of a significant indirect impact from the Ukraine conflict on the country’s economy and its banks.

To be sure, investor positioning across [futures markets suggests the return of a degree of optimism for banks](https://www.financedigest.com/bank-of-the-future.html "Bank of the future") over the past week.

We believe that [bond yields](https://www.financedigest.com/wall-st-stocks-fall-bond-yields-rise-as-china-drops-quarantine-rule.html "Wall St stocks fall, bond yields rise as China drops quarantine rule") and the inflation direction will re-align again with the growth direction, as it was ahead of the geopolitical shock,” JP Morgan strategists said. This should ensure that the correlations return to historical norms and the [gaps that are now evident get filled.”](https://www.financedigest.com/analysis-energy-hungry-europe-cant-look-to-u-s-shale-to-fill-any-opec-gap.html "Analysis-Energy hungry Europe can’t look to U.S. shale to fill any OPEC gap")

But that may take a while. Since Russia’s invasion of Ukraine, [banks experienced one of the worst twelve-month forward EPS revisions among European sectors](https://www.financedigest.com/sterling-rises-as-receding-bank-sector-worries-lift-sentiment.html "Sterling rises as receding bank sector worries lift sentiment"), according to Generali Investments. A move to cut off gas supplies to Bulgaria and Poland this week has only heightened [recession worries](https://www.financedigest.com/hotel-investors-should-they-be-worried-about-a-potential-economic-pause-delving-into-inflation-interest-rates-recession-etc.html "‘Hotel Investors – should they be worried about a potential economic pause?’ delving into inflation, interest rates, recession etc").

If I were to [create a new portfolio from scratch now it would be underweight financials](https://www.financedigest.com/how-to-create-financial-goals-for-your-business-in-2021.html "How To Create Financial Goals For Your Business In 2021") … European growth this year will be clearly lower than what was expected a couple of months ago simply because of this war and the [oil price,”](https://www.financedigest.com/oil-prices-steady-after-u-s-stockpile-swell.html "Oil prices steady after U.S. stockpile swell") said Jerome Schupp, a portfolio manager at Prime Partners in Geneva.

![European banks earnings forecasts](https://www.globalbankingandfinance.com/wp-content/uploads/2022/04/107-750x500.jpg)

Graphic: European banks [earnings forecasts](https://www.financedigest.com/centrica-names-obrien-as-new-cfo-raises-earnings-forecast.html "Centrica names O’Brien as new CFO, raises earnings forecast") – https://fingfx.thomsonreuters.com/gfx/mkt/jnvwerlxnvw/European%20banks%20earnings%20prospects.PNG

(Reporting by Danilo Masoni in Milan, Julien Ponthus and Samuel Indyk in London; Editing by Saikat Chatterjee and Jane Merriman)


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