In an Outlook 2017 note published on December 12, the analysts, led by Kian Abouhossein, said that they were upgrading their earnings per share estimates for the European bank sector for 2018, due to rising bond yields in the US and Europe, higher inflation expectations and higher Euribor forward curve.
The Outlook 2017 was entitled “Rising tide lifts all boats but volatility ahead calls for bottom up sensitivity to stock selection.”
However, the analysts warned that the European banking sector “will remain vulnerable to political risk in 2017” from various elections, including in the Netherlands, France, Italy and Germany, as well as uncertainty over the implementation of Brexit.
JP Morgan’s bank analysts wrote: “While the Italian referendum is out of the way, political event risk will remain a theme in 2017, in our view…The process of negotiating the UK’s terms of leaving the EU, following the planned triggering of Article 50 before the end of March, poses a further risk.”
When it comes to stock picks, the analysts said Lloyds Banking Group was its top choice for UK banks in 2017, with their preference for “higher-yielding, well capitalised banks with high cashflow generation below market valuation”.
They added that, in line with their cautious house view on emerging markets, they “are rebalancing our top picks portfolio towards domestic EU stocks and away from [emerging markets] for 2017”.
Lloyds had the potential to “surprise positively on capital return,” the JP Morgan analysts argued. They also said they believed that Lloyds’ strong capital position provides a material cushion to absorb further regulatory changes, noting that the UK bank performed well in the recent stress test.
They also said they see “better risk reward” in Credit Suisse, which has recently shifted from “top-down revenue to cost execution focus.”
They also described French bank Societe Generale, as “one of the cheapest stocks in our universe,” but they weren’t so positive about most Spanish and Italian banks.
JP Morgan said: “We continue to see limited value in southern Europe even in a blue sky scenario and have no exposure to pure play peripheral Europe apart from Santander, which remains our only [overweight] in Spain and Italy.”
Despite becoming more positive on the European banking sector, JP Morgan’s analysts said that they continue to have a preference for US investment banks Goldman Sachs and Morgan Stanley, which are better capitalised and do not have key litigations outstanding, such as over residential mortgage backed securities.
The analysts wrote: “In addition, US [investment banks] are clearly more geared to an improving US macro as well as benefit the most from potential tax cuts in the US.”
The analysts expect investment banks and wealth managers should benefit from ongoing volatility and uncertainty around central bank actions, with predicted growth in the trading of fixed income, currencies and commodities, which have suffered from a three-year period of decline.
“Both [investment bank] and [wealth management] players should also benefit from higher trending markets and if it is accompanied by a more stable macro environment, transaction volumes should pick up from very low levels seen currently,” the analysts wrote.
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