Rally by Eurozone Banks Still Has Legs

 | Jun 30, 2017 | 8:00 AM EDT
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If you have invested in eurozone banks, congratulations. You're up 23.8% year to date and 77% over the past year, judging by FactSet's Eurozone/Major Banks index. If you have not invested in eurozone banks, why, oh why, did you not at least take a look at them earlier?

Back in February, Spanish banks were doing much better, but investors overlooked their recovery because of worries about European politics. Since then, top Spanish bank Santander (SAN) bought Banco Popular for €1.0 ($1.14) in an orderly wind-down of the country's fifth-largest bank.

In March, Italian banks were recovering right under investors' noses. Since then, the country's second-largest lender, Intesa Sanpaolo (ISNPY) , absorbed two smaller failed banks, Veneto Banca SpA and Banca Popolare di Vicenza SpA.

A year ago, these bank failures would have caused investors to flee all the eurozone banks, but this did not happen this year. Indeed, any weakness could turn out to be an entry opportunity. The eurozone banks' rally still has legs.

The main reason is that, if there is one sector that could benefit from a tapering of European Central Bank (ECB) asset purchases, it's the bank sector.

For years, European banks were punished with negative interest rates on their deposits with the ECB and forced to cope with low net interest margins. But if monetary policy tightens just a little, some of the pressure on their margins will be relieved.

Another way banks could benefit from the tapering of ECB asset purchases is that more corporations likely will turn to banks for their borrowing needs. With a big debt buyer such as the central bank in the market, it was easier than usual for all companies to issue bonds, not just for those with bonds bought by the ECB. If the ECB slows down, banks will pick up the slack.

Yet another reason eurozone banks are likely to continue to do well is that, regardless of the market turmoil over the past days, the recovery in the region is strong. Because the ECB started its quantitative easing much later than the Fed and the Bank of England, the single European currency area is earlier in the business cycle than the U.S. and the U.K.

It also should be noted that the eurozone's businesses are less dependent on financial markets than ones in the U.S. and U.K. Consequently, the Federal Reserve's monetary tightening and this new "taper tantrum" could affect them less.

Eurozone business and consumer confidence in June was at its highest level since the financial crisis. In Germany, business confidence jumped to its highest level since 1991 this month, when it posted its fifth increase in a row, according to Ifo data released earlier this week. In Italy, consumer confidence improved more than expected in June, while business confidence also rose slightly.

Such confidence should help eurozone banks to work through their stock of bad loans (by no means small) faster than previously thought. A strong recovery would lift the value of collateral as well as their customers' incomes, pushing at least some of these loans back into the black.

In FactSet's major eurozone banks index, there are four that have an "overweight" recommendation from analysts: French banks BNP Paribas (BNPQF) and Societe Generale (SCGLY) , Dutch bank ABN AMRO (ABMRF) and Austria's Erste Group Bank (EBKDY) . Investors could start their research with them.

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