Source: Zhitong Finance

Over the past three years, European bank stocks have surpassed Bank of America stocks and the NASDAQ index. In the next few days, most major European banks will announce their results, and this rise will face a critical test.

Optimism about earnings growth and increased return on capital formed the basis for European bank stocks to continue to rise this year. The Stoxx 600 Bank Index rose 17%, the biggest increase of any sector, reaching its highest closing level since 2015.

Richard Halle, fund manager at M&G Investment Management, said that the company's European Strategic Value Fund's current increase in European bank stock positions is at the highest level since its establishment 16 years ago.

“Our expectation is that profit forecasts may be flexible,” Halle said. The industry expects Europe to cut interest rates “drastically” this year.

After more than 10 years of poor performance, the current round of rebound in the European banking sector has entered its fourth year.

Since the end of 2020, the Stoxx 600 Bank Index has risen 82%, beating out all sectors from US tech stocks to Bank of America stocks, while$UBS Group (UBS.US)$,$Deutsche Bank (DB.US)$and Spain$Banco Santander (SAN.US)$Recently, they have all hit multi-year highs. The Berenberg strategist said that since 2021, European banks have been the only sector in Europe or the US that has outperformed the market every year, and this has been the case so far this year.

The European banking sector has outperformed other major indices since 2021

The key to the future performance of European bank stocks will be the ECB's actions. The ECB's unprecedented rate hike cycle boosted banks' loan margins. As the ECB prepares to ease monetary policy, the level of terminal interest rates will be an important factor in determining the sustainability of earnings.

Ana Botin, chairman of Spain's Santander Bank, predicted last week that terminal interest rates in Europe will be around 3% and the US will be around 4%. This “is not a bad thing for commercial banks.”

From a valuation perspective, European bank stocks are still one of the cheapest sectors in the region, with an expected price-earnings ratio of 7.4 times, which is comparable to the level during the global financial crisis. This is 45% lower than the general market and 35% lower than Bank of America stocks.

The valuation of European bank stocks is close to historic lows

Not everyone is optimistic. Barclays analysts led by Paola Sabbione said that the strong performance of European bank stocks meant that the industry “may be more susceptible to fluctuations in performance, and unprofitable individual stocks will be severely punished by the market.”

Bloomberg Intelligence anticipates a “weak net interest revenue trend” in the first quarter and confirms a reversal in the profit upgrade cycle.

Investors were undeterred, however, and they pointed out that the economy is still resilient, and Europe's low credit spreads and default rates may curb non-performing loans and maintain profit elasticity.

María Torres, fund manager at Mapfre Asset Management, said: “The industry will continue to maintain its profit momentum this quarter, and the upward risk of earnings expectations is mainly driven by the increase in profit margins in 2024.”