The key is the yield curve, or rather its gradient. In recent years, as interest rates in developed markets have headed toward zero and quantitative easing has continued apace, so yield curves have flattened and bank margins have shrunk.
But, on the evidence not only of the BoJ and Fed decisions on Wednesday, but also recent comments by the European Central Bank, there is a growing desire on the part of central banks to see a steepening in the curve.
While the BoJ’s latest foray into untested monetary policy has so far received a mixed reception, it does directly address concerns over the steepness of the Japanese government bond curve. Equally, a second rate hike is now expected in the US in December, following the growing dissent within the committee – three members voted to hike in September. This increase would be expected to be positive for the banking sector.
Likewise, there are growing noises from within the ECB that not only should the yield curve steepen, but also that regulation needs to, perhaps be reconsidered.
In a speech three days ago by, Yves Mersch, a member of the executive board of the ECB, said, while addressing financial sector weaknesses was an important step in the recovery of the global financial system following the collapse of Lehman Brothers, regulators also “need to keep in mind the challenges banks are facing as they adapt to a new operating environment.”
It is for these reasons that Nicolas Walewski, manager of the Alken European Opportunities Fund said it is planning to step up its exposure to the sector.
For Olly Russ, manager of the Liontrust European Income Fund it is also for these reasons that “banks are about to become interesting”.
Speaking at an investment dinner in London, Russ told our sister publication Portfolio Adviser that, while he currently prefers insurers and some Italian asset managers, “if we have seen a bottoming in interest rates in the US, value could be poised to outperform and the value is in financials, where yields are highest and price earnings ratios are lowest”.
Underlining this point, Russ said that European banks have been historically, and still remain highly correlated to US yields as is evident from the graph below which plots the performance of European banks relative to the MSCI Europe in grey and the US 10-year yield in green.
It is not, however, only within the context of Europe that investor interest in banks has been piqued.
Speaking on the PA Podcast, Guy Monson, chief investment officer at Sarasin & Partners said that in recent years, the power of central bank intervention has been so massive, that it has tended to crowd all other investment themes out of the picture.
However, he is of the view that this is beginning to change and that if the “repression bull dozer” moves a little out of the centre of the picture it will open up a chink that will start to let out a number of other “tremendously exciting drivers” – one of them being the rehabilitation of banks.
“We have a vast range of investments today that have benefited hugely from repression and we have one that has been penalised – banks.”
Adding that if the world is, indeed, at the beginning of a normalisation trend, then banks could move front and centre.
Asked where he is looking, he said: “The obvious place is the US where the train is furthest down the business cycle. And it is interesting to note that in the second half of this year, banks have been the third best performing global sector having been distinctly the worst for the previous five quarters. secondly they seem to be meeting their targets reasonably well and thirdly there are huge efficiency and cost gains.
“And I expect the returns to be slightly more utility like rather heavily regulated, simple business models, but unlike utilities like a rising rather than a falling interest rate.”
Theoretically, banks stand to benefit from an increase in interest rates and a steeper yield curve that would accompany them, but as has been clear in recent years, theory and practice haven’t always walked hand in hand. And, while there is a growing cadre of investors that are beginning to look favourably at the space, all remain understandably cautious. It is clearly a space to watch, but perhaps not quite yet an allocation decision to take to the bank.
