European recovery favours the banks

The initial stages of the recovery post the financial crisis was primarily led by the US, but now other major economies, most notably Europe, are catching up.

Given the improving macro backdrop on this side of the Atlantic, we think that European equities are well positioned to close the valuation gap with their US counterparts. 

Against that backdrop our view is that European financials are set to begin a period of outperformance. The banking sector is the largest in the European index and is highly geared to the domestic recovery in peripheral regions. There is also the expectation that the European Central Bank (ECB) will end its quantitative easing programme later this year and the possibility of a rate hike next year, which as we have seen in the US, should be good for European banks’ profit margins. 

As the positive macro picture continues to improve, this should translate into earnings expansion from loan growth and higher net interest margins as yields rise. Valuations are also attractive relative to historic highs and US equities.  The banking sector currently trades on a PB (price-to-book) of 0.8x, which offers an attractive entry point.