Bank valuations is a cause for concern

Bank valuations is a cause for concern

18. toukokuuta 2020

The volatile stock market continues to prevail. The optimists choose to look beyond the upcoming weak Q2 2020 company results towards a presumably rapid recovery in V format. We ourselves are concerned about the severely negative effects of the economy that the shutdown already has had. We see the valuation and state of the banks in Europe and the US as an indication that this recession will be both palpable and prolonged.

The world´s stock exchanges with New York at the forefront have seen a sharp recoil on the course decline that began in March 2020 in connection with the Covid 19 outbreak. It now looks pretty good at first sight. This is since the death toll appears to have peaked in April, whilst countries are now cautiously opening their economies again.

To some extent, the stock market also looks beyond the extremely weak company reports that are expected for the second quarter of 2020. But there are several indications that the market´s state of health is not the best. One such example is the valuation of the banking sector in Europe and the United States.

There is no tendency of a bounce in the Eurostoxx Bank Index above. In a previous weekly letter we wrote about the bad state of the European banking system with its epicenter in Italy. As a result of the low interest environment, European banks have never been able to accumulate profits that could have served as a buffer for any losses that now is waiting. In addition, economic growth has been weak in recent years, especially in Europe.

Now we will see increasing credit losses in the wake of the Corona pandemic. The spreading effects on failing banks, mainly in Southern Europe, to the other European banks have been well documented since the Euro crisis in 2009.

Fundamentally, it is not unlikely that the USD will continue to gain strength against the euro. The EUR/USD is nevertheless holding up well but is pushed downwards towards support around 1.077. In case of a break below the 1.077-level the next level can be found around 1.063:

The European banking sector is currently valued at about half its booked equity, which is an indication of an imminent crisis. Given an exchange with a lending of approximately 15 times the equity at least when looking at the Nordic banks, it is easy to see a strong leverage effect ahead that could go in the wrong direction.

We don´t need to go any further than to Nordea, which is the most European bank share listed in Stockholm to see a similar price pattern. The Nordea share is traded at 13.7 times the last twelve months reported profit, but only at 68 percent of shareholders’ equity. Then the valuation is higher in Swedbank with 81 percent of equity. This is despite a reported loss after credit provisions in Q1 2020.

Nordea, shown in the daily graph below is trading underneath its EMA9 and MA20 meaning that the short-term trend is downward sloping. One may also see that the share is balancing on the upwards sloping short trendline-line. Note also how MACD has generated a sell signal:

The Swedbank share is clearly under pressure trading below EMA9 as well as MA20 in the daily graph:

In the monthly graph below one can see how the share is back at levels from 2012. A break below Fib 61,8 below and a possible target is SEK 75:

At the same time, banks are now starting to charge higher interest rates on both corporate and private loans, as their own funding through the secondary market has become more expensive. The return requirements for real estate have also increased, though it is a combination of higher interest costs and lower anticipated rental income. This is relevant to the banks as real estate is a large segment for their lending. But the are also other sectors such as hotels, airlines, retailers, industry subcontractors, oil companies and others, which will weigh the banks’ earnings going forward.

A part of this lending to companies and real estate is also on the corporate bond market, which is heavily strained, with limited liquidity, especially in Sweden. It is interesting to note that the Swedish Riksbank is now considering starting to buy back bonds, which is a step in the right direction. The euro bond market currently works better than the Swedish counterpart and especially so for the larger companies.

If we study the HYG ETF, which reflects the market for high-risk loans (just over 1,000 different US corporate loans are included in this instrument), it looks a little better. Here, the relationship with the S&P500 index is quite strong, with the rebound up to around Fibonacci 61.8 which has taken place since 23 March.

The state of the banking sector in the United States does not appear to be quite as bad as in Europe, as the graph below shows. But Banking & Finance were worst of eleven S&P500 sectors, with only 50 percent of earnings in Q1 2020 better than forecast.

The US, with its fast-moving economy, has been hit hard by the Covid-19 crisis with a total of 36 million job losses, including 3 million last week. A large proportion of these are employees who earns less than USD 40,000 per year and consequently will cut their consumption drastically. Retail sales in the US fell by 16 percent in April (reported on 15 May), which was clearly worse than anticipated. Add to that a record low oil price that is pushing the US shale companies which is also weighing on the American banks, as well as the country´s corporate bond market.

So, in summary, we see the valuation of banks in Europe and the US as a warning sign that the recent rise in share prices has been narrow and focused on i.e. the US tech sector. The Volatility index (VIX) below shows that the market appears to have calmed down. But as earlier reminded, we rather think that this provides an opportunity to hedge equity portfolios at present.

On Thursday, S&P 500 bounced nicely on Fib 50 and is now struggling to break above EMA9 and MA 20 to reclaim the short rising trend:

Note how both EMA9 and MA20 is falling and that MACD has generated a weak sell signal.

Tech heavy Nasdaq also bounced nicely on a support made up by the 8 950-level and MA20. The index also managed to close Friday’s trading above EMA9.

Momentum is positive but fading. In case of a break down below MA20 and 8 950, the next level can be found at MA100 around 8 677.

Technically, the risk is more obviously seen on the downside. OMXS30 is struggling slightly above the support-level around 1 480:

Note that MACD has generated a weak sell signal. In case of a break to the downside, the next level can be found around 1 413 where Fib 23.6 meet up.

German DAX is also wrestling with support levels but is being pushed downwards by a falling MA20 and EMA9:

A break below the 10 125-level calls for further downside to around the 9 566-level where Fib 23.6 meet up.

Brent oil has gained some good momentum and closed Friday’s trading above the falling trendline. Brent still have some resistance levels to fight but MACD has generated a buy signal and the 37 USD per barrel-level is certainly in sight:

Legal notice

This information is in the sole responsibility of the guest author and does not necessarily represent the opinion of Bank Vontobel Europe AG or any other company of the Vontobel Group. The further development of the index or a company as well as its share price depends on a large number of company-, group- and sector-specific as well as economic factors. When forming his investment decision, each investor must take into account the risk of price losses. Please note that investing in these products will not generate ongoing income.

The products are not capitalprotected, in the worst case a total loss of the invested capital is possible. In the event of insolvency of the issuer and the guarantor, the investor bears the risk of a total loss of his investment. In any case, investors should note that past performance and / or analysts' opinions are no adequate indicator of future performance. The performance of the underlyings depends on a variety of economic, entrepreneurial and political factors that should be taken into account in the formation of a market expectation.


15.7.2020 10:49:58

 

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