Markets Insight

Equity market bulls, particularly in Europe, justify their stance on the claim that recent economic weakness represents a temporary soft patch.

Such optimism looks increasingly misplaced. In particular, the long-running poor performance of eurozone banks has been intensified by the latest escalation in trade protectionism by Donald Trump’s administration.

StockMarketNews.Today – US plans to impose tariffs on a further $200bn of Chinese imports duly ignited renewed selling in commodities and base metals on Wednesday, knocking related equity sectors such as materials, miners and industrials.

At a time when central banks are withdrawing their support for asset prices at an accelerating pace, signs of weaker economic growth outside of the US have gnawed away at the performance of many world equity markets.

This is driven by the dire performance in financials. Japan’s Topix banks sector has dropped 21 per cent from its mid-January peak while even in the US, the S&P 500’s financials sector is 10 per cent adrift from this year’s top.

But the continued weakness in financials represents a far more worrying signal. The Euro Stoxx bank index is heading back towards last month’s nadir, which was itself the lowest level since late 2016. The selling pressure is keeping this basket of 27 lenders locked in a bear market, off more than 20 per cent from its high for the year set in January.

For Eurozone equities the stakes are high. Banks and other financials comprise a fifth of the Euro Stoxx 50, making them the heaviest-weighted sector in the broader market. Until eurozone financials find their footing, forget the prospect of a stronger recovery for the broader stock market, let alone closing the gap with Wall Street.

EU-banking-crisis-eurozone-banks

The US, unlike Europe, is buoyed by the dominance of technology companies that are stupendous cash flow generators and growth machines.

This suggests that investors had good reason to pull $45bn of cash from mutual funds and exchange traded funds that track European equities over the past 17 weeks according to EPFR, the longest losing streak since 2016.

Investors may currently cast an eye across the European banking sector and think that the time is ripe to buy the latest dip. But the prospect of balance sheets being cleaned up once and for all still appears low. This explains why the Euro Stoxx bank index trades at 0.7 times book value. Expectations for a much-needed consolidation in the banking sector  that can help boost lacklustre profitability also seem like wishful thinking at this stage.

As political risk looms with the possibility of another bout of Italian-inspired political drama and intensification of trade conflict, it is deeply troubling that banks are performing so badly before the ECB ends quantitative easing later this year.

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