(Bloomberg) - Investors betting on a further outperformance in European bank stocks in 2023 have been caught wrong footed by the meltdown in shares of Credit Suisse Group AG and fears of a recession.
The sector — among the year’s biggest gainers until last week against the backdrop of rising interest rates and a resilient economy — is now barely positive in 2023 after sinking 14% since March 9 as the collapse of US lender Silicon Valley Bank triggered concerns about the health of the global financial system. The crisis at Credit Suisse Group AG, which sank to a record low Wednesday after a top investor ruled out any additional support, compounded those worries.
The developments mark a stark reversal in investor sentiment, which was overwhelmingly optimistic coming into the year on wagers that higher interest rates would boost both earnings and bumper shareholder returns at the region’s lenders. A Bank of America Corp. survey of regional fund managers showed banks were the most popular sector overweight in February.
“With the expectation of higher rates boosting margins and high solvency, the overweight position was understandable for many,” said Guillermo Santos, head of strategy at Spanish private banking firm iCapital. “But contagions in markets are very rapid, especially from a large institution such as Credit Suisse. This rout has caught many on the wrong side of the bet and the situation is turning out to be very messy.”
Positioning in banks was very extended ahead of the latest turmoil. JPMorgan Chase & Co.’s European derivatives strategist Davide Silvestrini points out that net long positions in Euro Stoxx banks’ futures surpassed €3 billion ($3.2 billion) before this week’s selloff, near the highest since the Ukraine war erupted a year ago. Bullish option trades had also accumulated, hence the “overreaction,” Silvestrini said.
The banking crisis in the US following the sudden failure of SVB and two other lenders has also led investors to swiftly temper expectations of rate hikes by the Federal Reserve, and as a result, the European Central Bank. That leaves earnings at European lenders particularly vulnerable as they’ve still seen estimate upgrades outnumber downgrades this year, according to a Citigroup Inc. index. Estimates at US banks, on the other hand, have been consistently reduced over that period.
Investor bets on European banks this year were probably premature, said John Leiper, chief investment officer at Titan Asset Management.
“There will be greater competition for deposits and pressure on bank earnings, and lenders in the UK and Europe will be hit by this,” he said. “There’s scope for European banks to ‘catch down’ with the US and in a broader risk-off scenario, rationality may go out the window with a pick-up in general contagion risks.”
Since the selloff started last week, the worst-performing banks in Europe include Spain’s Banco de Sabadell SA, Bawag Group AG of Austria, France’s Société Générale SA and Germany’s Commerzbank AG, all down about 20%. All 42 stocks in the Stoxx 600 Banks Index have fallen.
And despite the decline in investor exposure since last week, positioning on European banks remains net long, raising the threat of further short-term weakness, according to Citigroup strategist Beata Manthey.
Still, market strategists at firms including UBS AG and Sanford C. Bernstein said the sector remains attractive amid cheaper valuations, strong earnings momentum and growing share buybacks.
Read More: UBS Strategists Say Buy the Dip in European Banks After Selloff
“We remain bullish on European banks: the investment case on fast-growing net interest margins is still intact,” said Fabio Caldato, a partner at Olympia Wealth Management. “We are monitoring the current turmoil, but we are still keen to invest in the more solid banks.”
By Sagarika Jaisinghani and Macarena Muñoz
With assistance from Chiara Remondini and Michael Msika