The "rising logic" of global bank stocks: populism, fiscal easing, and currency appreciation

Global bank stocks are facing multiple favorable factors! UBS pointed out the "core logic" behind the rise of global bank stocks in its latest research report. The macro-level favorable factors include populism, fiscal easing, appreciation of local currencies, as well as structural improvements and attractive valuations.

On July 24, according to news from the Chasing Wind Trading Desk, UBS's global equity strategy team reiterated its long-term overweight stance on bank stocks in its latest research report and presented the core logic for the rise of bank stocks:

Populism has raised concerns about fiscal easing, pushing up bond yields, and bank stocks are one of the biggest beneficiaries of rising bond yields; as a highly localized industry, bank stocks benefit significantly from currency appreciation in regions like Europe and Japan.

UBS also pointed out in the report that from the perspective of structural improvement and valuation advantages, the banking sector has undergone deleveraging and strict regulation in the post-financial crisis era, and now its risk resilience has significantly improved, with headwinds such as lawsuits and fintech impacts weakening.

Finally, UBS added that multiple indicators support the allocation of bank stocks, including moderate crowding, strong earnings revisions, and macro models indicating upside potential. The bank recommends focusing on bank stocks in Europe, Japan, and certain emerging markets.

Macro Level: The "Perfect Storm" of Populism, High Interest Rates, and Local Currency Appreciation, Private Sector Lending Growth Rebounds

1. The report states that 2024 will be the first time in 120 years that all major developed markets have lost power or majority seats. The typical political response to such changes is to increase spending, tighten immigration policies, and in some cases, raise the minimum wage.

UBS pointed out that one of the biggest macro risks currently is the relaxation of fiscal discipline brought about by the rise of populism.

For example, the report estimates that the U.S. needs a fiscal tightening equivalent to about 3% of GDP to stabilize government debt, but political realities are leading to more fiscal spending. This "loose fiscal" environment will inevitably force "tight monetary" policies, pushing up long-term government bond yields.

Historical data shows that banks perform second best when TIPS (Treasury Inflation-Protected Securities) yields rise, closely related to the steepening of the yield curve. Therefore, investing in bank stocks has become an effective strategy to hedge against this macro risk.

2. UBS maintains a bearish view on the U.S. dollar, with the underlying logic including overvaluation of the dollar (deviating by 1.4 standard deviations), the U.S. net external debt reaching 90% of GDP, and UBS predicting that the Federal Reserve's rate cuts will exceed market expectations (a 1% cut by the end of the year).

The bank believes that in the context of a weakening dollar, the euro and yen are expected to strengthen. Since bank profits are highly dependent on the local economy, currency appreciation will directly enhance their asset values and profitability. Analysis shows that banks are one of the best-performing sectors when the euro or yen appreciates.

Data shows that European bank stocks perform best when the euro and manufacturing PMI rise, and their current performance is only consistent with these variables; any further appreciation of the euro or improvement in PMI will drive excess performance in bank stocks

3. UBS stated that the turning point for private sector credit growth has emerged. In the European and American markets, the leverage ratio of the private sector (households and enterprises) is at an unusually low level. As the economy stabilizes, credit demand has shown a significant rebound, especially in Europe, where corporate loan demand in France and Italy has grown strongly.

This indicates that the core business of banks—loan growth—will enter a new upward cycle.

Valuation Bottom: The Market Has Priced in a "Non-existent Recession"

UBS believes that the current valuation level of bank stocks is highly attractive, as it has overly reflected the market's concerns about an economic slowdown. The report analyzes this from three aspects:

1. Price-to-Earnings Ratio (P/E) Significantly Discounted: Whether in Europe or the United States, the forward P/E ratio of bank stocks is about 10% discounted compared to its historical norm. This means the market has already digested about a 10% earnings downgrade in advance.

2. Cost of Equity Implies Pessimistic Expectations: The report argues that the 11.6% cost of equity for European banks is too high compared to the 6% yield of their permanently write-down CoCo bonds. If the cost of equity is conservatively lowered to 10%, it implies that the market has priced in a profit downgrade of up to 14% for European banks.

UBS points out that to achieve such a degree of profit decline, interest rates would need to drop by more than 1 percentage point or credit charge-offs would need to rise by 20 basis points, both of which would require a sharp economic slowdown, contrary to UBS's forecast of global GDP growth of 2.9% and 2.8% in 2025 and 2026, respectively.

3. Insights from Australian Banks: The report uses Australian banks as an example, noting that their tangible return on equity (ROTE) is lower than their European counterparts, yet their price-to-book ratio (PB) is as high as 3 times. This indicates that driven by factors such as consolidation, high returns, and cash flow, the banking sector has the potential for a complete revaluation.

Structural Improvement: The Banking Sector's Risk Resistance Capacity Significantly Enhanced

UBS stated that compared to the period before the global financial crisis, the business models and risk conditions of banks have fundamentally changed and become more robust. The report also provided the following three points of "explanation":

1. Significantly Enhanced Recession Resistance: The Swedish case proves that bank stocks have greatly improved immunity to economic recessions.

During the recession when Sweden's GDP fell by 2.4% and housing prices dropped by 12.5%, the non-performing loan rate (NPLs) of banks did not significantly rise, and their stock prices even outperformed the market during the recession. This is attributed to lower borrower leverage, strict regulatory stress tests, and enhanced risk control within the banks.

2. Significant Reduction of Non-Macro Headwinds:

• 1) End of Deleveraging: Regulations have even begun to relax, such as the UK postponing the implementation of certain Basel III rules, and the US is expected to ease capital requirements for large banks.
• 2) Reduced Risk of Litigation and Fines: The peak period of exorbitant fines in the post-financial crisis era has passed, and banks' risk control has improved, no longer being the target of economic issues.
• 3) Disruption Risk from Fintech is Controllable: Regulatory scrutiny of fintech companies has tightened, with disruptors accounting for only about 3% of the deposit base, and some companies have even been acquired by traditional banks.

3. The Rise of "New Consumption Leaders": Traditional high-yield sectors (such as consumption leaders) are facing various disruptive challenges, while banks, with their robust profitability and capital return plans, are becoming a new reliable source of income.

European banks are expected to have a total return (dividends + buybacks) of up to 8.3% by 2025, while US banks will reach 7.2%, showing a clear advantage over all major industries.

Multiple Indicators Support Bank Stock Allocation

UBS believes that from a tactical perspective, multiple indicators support the allocation of bank stocks.

1. Moderate Crowding, Strong Earnings Revision: Bank stocks rank 8th in terms of crowding among 29 global industries and 9th in Europe, which is relatively moderate.

In UBS's European scorecard, bank stocks rank 2nd in earnings revision and 5th globally.

2. Macroeconomic Models Indicate Upside Potential: UBS's macro model for bank stocks shows that based on the performance of the Purchasing Managers' Index, currency, and bond yields, European bank stocks are performing only in line with these variables. Further appreciation of the euro (UBS predicts the euro/USD will be 1.23 by the end of the year) or an increase in the Purchasing Managers' Index will drive bank stocks to outperform UBS pointed out in its report that it is particularly optimistic about Europe and Japan, as these regions are nearing the end of their interest rate cut cycles or are in the early stages of rate hikes, and will benefit from the appreciation of their local currencies. At the same time, some emerging markets (such as Brazil) are attractive due to the expectation of a decline in interest rates from high levels. The report is relatively cautious about U.S. banks, mainly due to headwinds from slowing domestic demand and a weakening dollar.

The bank prefers European retail banks due to their high customer stickiness and relatively low business risks; it is optimistic about the scale effects and regulatory advantages of U.S. investment banks; and it is positioning itself in emerging markets through bank stocks that hold a large exposure to cheap stocks in those markets