US banks underperformed the broad market significantly in March 2022 after two consecutive months of better dynamics, but it was again the month with negative performance in absolute terms.
EXECUTIVE SUMMARY
US banks underperformed the broad market significantly in March 2022 after two consecutive months of better dynamics, but it was again the month with negative performance in absolute terms.Thus, BKX index tumbled by 7.5% MoM vs +3.6% MoM of SPX index. Absolute March 2022 performance was -1.2 std from the mean monthly performance and it is in the bottom 11% since the index inception. Relative March 2022 performance was -10.7% MoM. It is -2.2 std from the mean monthly performance and it is in the bottom 3% of relative performance vs SPX index since the index inception. Despite much higher rate expectations, US banks underperformed the broad market significantly in the recent time as a result of much higher geopolitical risks and expected noticeable deceleration of US GDP growth.
US banks' dynamics were relatively uniform in March 2022 with negative dynamics for all our group of banks, except for 2 financial institutions.Among the worst performers were consumer finance companies, such as DFS, COF and SYF, which decreased by more than 10% MoM. In turn, the best performers were trust banks, which are benefited from sharp rates growth.
Earnings season of US banks will start on April 13, 2022, when 1Q22 results will be provided by JP Morgan. After that, all members of BKX index will provide quarterly results within two weeks. US banks reported noticeably better both revenue and EPS figures in last 7 quarters, but we don’t expect that 1Q22 figures will be much higher than the current estimates as the process of releasing reserves has ended while short-term rates, which are the benchmarks for most of the loan portfolio, have just started to rise. Moreover, 1Q22 EPS estimates even decreased on ytd basis driven by noticeably higher expenses guidance during 4Q21 earnings season. Thus, according to Bloomberg consensus, a median decline of 1Q22 EPS of our group of banks was -2.5% ytd, but +18% vs the end of 2020 (as of the end of March 2022). 1Q22 EPS estimates dynamics was negative on ytd basis for 17 out of 23 banks from our group of banks. In turn, full-year estimates for both current and next year were revised up on ytd basis and were much higher vs the end of 2020. A median growth of EPS 2022/2023 of BKX index members was +1.7%/+3.0% ytd, respectively, or +19.7%/+20.5% vs the end of 2020. 1Q22 revenue estimates increased by 2.2% ytd, being markedly higher vs the end of 2020, +11.5% since then.
NIM/NII should be the main profit driver in coming quarters given an explosive growth of both current and forward yield curves.Rate expectations continue going up due to the start of the hiking cycle and much more hawkish Fed as a result of still very high and even accelerating inflation in the US. Moreover, the inflation will be elevated for longer than it was expected as a result of the skyrocketing of the commodity prices after Russia’s invasion of Ukraine and subsequent sanctions. Unsurprisingly, the dot plot moved substantially up in March 2022. Now it implies 7 rate hikes in 2022 (vs just 3 in December 2021), three more in 2023 (in-line with December 2021 projections), and flat FF rate dynamics in 2024 (vs 2 hikes as of December 2021 projections), which assumes the federal funds rate at 2.8% at the end of 2023 vs just 1.6% in December 2021. The market is even more hawkish now, implying more than 8 rate hikes in 2022 (including the March one) and two more in 2023. However, the market also implies a rate cut in 2024 while the yield curve is expected to be inverted in 2 years.
Although risks have increased significantly in recent weeks, fundamentals of US banks will probably continue improving in 2022. The threat of longer than it was expected period of high inflation forces the Fed to be as hawkish as it can even at the cost of increasing stagflation risks. But it seems that US GDP growth will remain solid albeit noticeably slower than expected at the beginning of the year. So, faster rates growth and accelerating of the loan growth will remain the key profit drivers for US banks even in case of the faster normalization of the credit costs and higher OpEx growth driven by inflation and tech investments. Regulatory risks also remain on the agenda but we think that the key risk for banking stocks is more significant than it is expected slowdown of the economy. Given significant outperformance of US banks during the last year, we think that banking quotes could remain quite volatile in the rest months of 2022, as it was in 1Q22. But we still remain bullish on US banks, which are trading at attractive multipliers. Thus, banks are trading at -0.6/-0.5 std on P/E CY (as of March 31, 2022) or -1.2/-0.9 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 -1.1 std and -1.6 std from the sample mean (2010-current moment) for P/E CY and P/E NY, respectively. On P/B, banks are trading at +0.8 std from the sample mean (2010-current moment) vs +2.2 std for SPX index.
EU banks decreased on both an absolute basis and a relative basis in March 2022 for the second month in a row after two consecutive months of significant growth in absolute terms. Thus, on an absolute basis, SX7P decreased by 3.2% MoM in March 2022, or -0.5 std from the mean, and it is in the bottom 25% of absolute monthly performance of SX7P index. In turn, relative monthly performance was -3.8% MoM, or -0.9 std, and it was in the bottom 13% of relative monthly performance in SX7P index history. Nonetheless, EU banks still continue outperforming the broad market slightly in 2022 after clearly strong 2021 year, when they added 34% (+9.6% on relative basis). On the other hand, SX7P index underperformed in each of 2018-2020 years. So, it is still 25.7% lower than it was at the end of 2017, underperforming STOXX 600 index by 36.6% over this period.
Dynamics of EU banks were quite mixed in March 2022. Among the key underperformers remained UniCredit and Raiffeisen Bank because of their relatively high Russia’s exposure. Barclays was the worst performer, losing 18.9% MoM, because of the news about $600 mln loss on product sales.
European banks' dynamics were relatively weak in the two last months, driven by much higher risks for the EU economy because of Russia’s invasion of Ukraine, which would have material impact on economic activity in the euro area (macro data of the first two months of the year were relatively strong) through higher energy and other commodity prices, the disruption of international commerce and weaker confidence. Notwithstanding, the ECB remains quite optimistic about the future, expecting that over the medium term GDP growth would be driven by robust domestic demand, supported by a stronger labour market. Inflation is key threat at the moment. So, the ECB was quite hawkish in March, deciding to accelerate tapering. Unsurprisingly, rate expectations skyrocketed ytd. On the other hand, EU banks’ NII forecasts for the nearest two years were almost unchanged ytd, although the market expects that the key rate will become positive again as early as in 4Q22. Net income estimates for the nearest years were even negative ytd.
Earnings momentum of EU banks still remains relatively strong, from our point of view. But the situation may change noticeably in the near future. The key question is whether the Eurozone will be able to avoid a recession. If the answer is yes and if rates rise in line with current expectations, the rally in EU banks may be resumed in the coming months as rates growth hasn’t fully priced yet. Moreover, EU financial institutions still look relatively cheap. Thus, a discount to historical averages is 19% (-1.1 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 28% as of March 31, 2022 vs the average since 2010 of 22%, or -0.8 std. A discount to the broad EU market is more than 44% vs average of 30%, or -1.6 std. At the moment, we can’t answer yes to the key question about a possible recession in EU with certainty. So, we remain cautious about near term prospects of EU banks, especially banks with high Russia/CEE exposure. And we still prefer US banks over EU financial institutions.