Investors aren't too impressed with Europe's finance firms.
If you've any doubt, just look at how financials dominate the MSCI Europe Value Index – a collection of some of the cheapest stocks in Europe. Financials account for 74 of the 240 stocks in the index. The next most unloved companies are industrials, though there's only 37 of them.
By any measure, financials are cheaper than the broader European market. The price-to-earnings ratio (based on 12-month trailing earnings, excluding negatives) of the MSCI Europe Index is 18.2, whereas it's 12 for the MSCI Europe Financials Index. The price-to-cash flow ratio of the Europe Index is 6.2, for the Financials Index it's 2.3. And the price-to-book ratio of the Europe Index is 1.7, while it's 0.8 for financials. You get the picture.
Investors blame their aversion on various factors. Brexit has reintroduced uncertainty in Europe on a scale not seen since the 2008 crisis. Fintech upstarts are eating into once-reliable sources of bank revenues such as payment services and investment management.
And let’s not forget the mountain of new financial regulation. It’s not just the cost of compliance; regulators are calling banks to account for stepping out of line. The U.S. Department of Justice is said to want Deutsche Bank to pay $14 billion to settle an investigation into mortgage securities. (Although few observers believe it will pay anywhere near that.)
At first glance, the sagging profitability of European financials seems to validate investor fears. Return on assets for the MSCI Europe Index is 0.7 percent, whereas for the Financials Index it's 0.3 percent. Return on common equity for the broader index is 6.3 percent, and for financials it's 4.5 percent.
It turns out, though, that European banks aren't that unusual. Financials everywhere are relatively unpopular.
Consider that the P/E of the S&P 500 is 19.5 times, whereas for the S&P 500 Financials Sector Index it's 14 times. The P/CF and P/B ratios of the S&P 500 are 11.3 and 2.9, respectively, whereas for financials they're 6.3 and 1.1.
It’s the same in emerging markets. The P/E ratio of the MSCI Emerging Markets Index is 13.7, and 9.1 for the MSCI Emerging Markets Financials Index. Price-to-cash flow and price-to-book ratios show similar discounts.
As in Europe, finance companies in the U.S. and emerging markets have struggled to lift profit. ROE for the S&P 500 financials has not exceeded 10 percent since the crisis – a routine feat before 2007. ROE for the MSCI Emerging Markets Financials Index has declined every year since 2011.
That the financial services downturn has been global, not regional, suggests the problem extends beyond Europe’s borders. So maybe the real culprit isn’t Brexit or fintech or a monster Deutsche Bank fine. Maybe it’s something much more simple: sluggish global growth.
It’s no secret that many economies have struggled to expand since the crisis. It’s also no secret that slow growth is usually accompanied by uncertainty, low interest rates and bad debts – a deadly cocktail for finance. That’s pretty much how the last eight years have gone, and it explains why banks everywhere have struggled.
No one can say whether this environment is cyclical or longer lasting. If it proves cyclical, then financials could be a bargain at current valuations.
And it's not as if stagnation only stifles the finance crowd. No company is safe from it. Investors should ask themselves what will happen to more richly-priced non-financial stocks if global growth continues to be stubbornly slow. Then they should take another look at Europe’s unloved banks.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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