US banks underperformed noticeably in the last trading month of the year (as of December 23, 2021), the third consecutive month of underperformance despite to hawkish Fed and a growth of the rate expectations
EXECUTIVE SUMMARY
US banks underperformed noticeably in the last trading month of the year (as of December 23, 2021), the third consecutive month of underperformance despite to hawkish Fed and a growth of the rate expectations.Thus, BKX index decreased by 0.3% MtD vs +3.5% MtD of SPX index, the fourth month of positive dynamics over the last five. Absolute December performance (if the month ended on December 23) was -0.1 std from the mean monthly performance. It is in the bottom 45% since the index inception. In turn, relative December performance was -3.1% MtD. It is -0.6 std from the mean monthly performance and it is in the bottom 20% of relative performance vs SPX since the index inception. Despite clearly weak performance in three recent months, banks outperformed SPX in 7 out of 12 months of the current year. So, 2021 year nominal performance is the strongest one over the last 8 years, while relative performance is the strongest one over the last 5 years.
US banks dynamics were mixed again in December. Thus, consumer finance companies were among the outperformers. So, AXP and DFS added 7% MtD. On the other hand, high-growth companies were among the laggards. The key underperformer was Citigroup, which lost 5.5% MtD.
The earnings season of US banks will start on January 14, 2021, when 4Q21 results will be provided by JP Morgan, Wells Fargo, and Citigroup. After that, all members of BKX index will provide quarterly results within two weeks. US banks reported much better both revenue and EPS figures in the last 6 quarters, but we don’t expect that 4Q21 figures will be noticeably higher than current expectations as the process of releasing reserves is gradually fading, while short-term rates, which are the benchmarks for most of the loan portfolio, haven't started to rise yet. Notwithstanding, it is impossible not to admit that mid-term banking prospects have improved substantially since the last earnings season. Loan growth is accelerating while rate expectations have moved further up (with a high probability, rates will become a tailwind again as early as 1H22) and asset quality remains quite strong. So, positive EPS momentum, which began in 3Q20, remains. So, the estimates will continue to be revised up in the near future. Thus, according to Bloomberg consensus, median growth of 4Q21 EPS of BKX index members was +30.6% ytd but still -5% vs the end of 2019 (as of December 23, 2021). 4Q21 EPS estimates dynamics was positive on ytd basis for all members of BKX index, except for BK. Full-year estimates for both current and next year were also revised up meaningfully on ytd, but were roughly flat on qtd basis. Median growth of EPS 2021/2022 of BKX index members was +61.2%/+13.9% ytd, respectively, but projections were +14.6%/-4.4% vs pre-pandemic levels. 4Q21 revenue estimates increased by 5.8% ytd, still remaining markedly below pre-pandemic levels, -0.9% since then.
Despite to risks generated by Omicron variant spreading, fundamentals of US banks will continue improving in 2022. The key drivers of revenue and profit growth will be the start of the hiking cycle (the dot plot implies three rate hikes in 2022, three more in 2023 (but 8 of 18 participants expect 4 or more hikes), and two hikes in 2024, which assumes the federal funds rate at 2.1% at the end of 2024) and acceleration of the loan growth which will be driven by C&I loans (+2.3% qtd as of December 8, 2021, but still -5.6% yoy). But this growth will be partly diminished by inevitable normalization of the credit costs, which were the key driver of profit growth in 2021, OpEx growth driven by inflation and tech investments as well as relatively weak dynamics of some fee categories such as mortgage and trading. Regulatory risks remain on the agenda, but we think that the key risk for banking stocks is a more significant than it is expected due to a slowdown of the economy because of rates growth, the effect of which can be enhanced by the introduction of restrictions due to the fourth wave of the pandemic. Given significant outperformance of US banks in the last year, we think that banking quotes could be quite volatile, especially in the first months of the year. Notwithstanding, we remain bullish on US banks, which are still trading at attractive multipliers. Thus, banks are trading at -1.2/-1.1 std on P/E CY (as of December 23, 2021) but +0.6/+0.8 std on P/E NY (on the basis of samples from 2000 and 2010 years to current moment) relative to historical averages. As for relative to S&P 500, banks are currently trading at -1.9 std and -1.3 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading at +0.6 std from the sample mean (2010-current moment) vs +2.6 std for SPX index. Our top picks for 2022 in US are JPM, USB, CFG, RF, and SIVB.
EU banks increased on an absolute basis in December 2021, after a substantial decline in November. They outperformed the broad market either, the fourth month of stronger dynamics over the last five. Thus, on an absolute basis, SX7P increased by 5.1% MtD as of December 23, 2021, or +0.7 std from the mean. It is in the top 19% of the absolute monthly performance of SX7P index. Relative monthly performance was +0.7% MtD or +0.3 std. And it is in the top 36% of relative monthly performance in SX7P index history. Despite a significant decline in November, it was a very strong price performance in 2021, +32.7% ytd, after clearly weak dynamics in three previous years. SX7P index underperformed in each of last 3 years and it is still 21.9% lower than it was at the end of 2017, underperforming STOXX 600 index by 37.1% over this period.
EU banks dynamics were relatively uniform in December. In our group of banks just 6 out of 37 banks declined MtD as of December 23, 2021. The best performer was UniCredit, which increased by 26.4% MtD due to quite optimistic new strategic guidance.
European banks' dynamics were relatively weak in the last 2 months of the year, despite higher rate expectations, strong 3Q21 earnings season, still cheap relative valuations, and rising revenue/profit estimates. Uncertainty related to Omicron strain spreading poses some risks to economic recovery in the near term but mid-term drivers for EU banks remain intact, from our point of view. Indeed, rate expectations continue going up while the yield curve is getting steeper and steeper. The BoE has already started its hiking cycle and the Fed is likely to follow suit in the near future. The ECB tries to remain as flexible as it can but it can't help but tighten the monetary policy either. At least, the long end of the curve has already much higher ytd, while SX7P NII has already returned to a growth on yoy basis. Excess capital of EU banks remains quite high and the total average yield of SX7P index members could exceed 8% annually in the nearest years. Inflation pressure will inevitably lead to wage growth, but we expect that operating leverage will remain positive. In any case, banks are a good hedge against inflation, in particular, due to the fact that inflation and nominal rates have a high correlation.
Earnings momentum of EU banks remains quite strong. Due to positive EPS surprises and improved economic expectations, estimates have increased meaningfully in recent months. Thus, a median growth of FY22 NI was +16% ytd, implying flat yoy dynamics. As of FY22 revenue estimates, a median growth was +4.2% ytd, implying growth +2.2% yoy. FY22 DPS estimates added 18.4% ytd, implying a growth of 6.7% yoy. Notwithstanding, EU financial institutions still look relatively cheap. Thus, a discount to historical averages is 6.0% (-0.4 std at the moment from mean P/E NY of SX7P index members, sample from 2010 to the present), but a discount to US peers (on median P/E NY of BKX index vs SX7P index) is 33% as of December 23, 2021 vs an average since 2010 of 21% or -1.3 std. Discount to the broad EU market is more than 45% vs an average of 29%, or -1.8 std. So, we remain positive on European banks, but prefer US peers over EU ones due to much higher US rate expectations. Our top picks for 2022 in EU are UCG IM, DBK GR, RBI AV and BARC LN.