The first few days of August have confirmed the sense of frailty and the persistent fears represented by the cornelian dilemma faced by financial markets concerning the banking sector. Banks came under heavy pressure once again following the stress tests carried out among European financial institutions. The high score achieved by certain banks, particularly in France (Société Générale and Crédit Agricole) nonetheless rekindled hopes of a future rerating in the sector, which is now considered an ultra-regulated public service with heavy constraints weighing on returns on capital employed. As such, banks bear a strange resemblance to energy and environment stocks in the utilities sector, which may partly explain why they have underperformed, except that unlike true utilities, they do not benefit from the low interest-rate environment, which actually weighs on their interest margins.
A sustainable equity market rally, particularly in the eurozone, is almost inconceivable without a major contribution from the financial sectors, which are heavily weighted in European equity indices. For the time being, the majority of investors refuse to accept low valuations as an investment rationale, albeit increasingly compelling. Furthermore, the perceptible rise in fintechs has clouded the competitive landscape, which is now less clear-cut than in the past.
Whereas banks once unambiguously represented an omnipotent oligopoly within the financial investment sphere, they are now perceived by savers as being inexorably linked to systemic and sovereign risk. Italy perfectly illustrates this point. The Italian state is working to organise a bailout for the regional banks and, in doing so, is putting its own political credibility on the line. Central banks are now playing a key role in market mechanisms, by overseeing the prevention of economic risks. This factor was once again illustrated recently by the Bank of England cutting rates and extending its quantitative easing programme in an attempt to avoid a Brexit-fuelled recession.
Igor de Maack, Fund manager and spokesperson at DNCA. This article was finalised in August 8th, 2016.
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