Mystery behind European Banks vs Utilities PER differential

European banks

M&G Valores | In recent years the PERs of banks and utilities have suffered fluctuations because of the cyclical phases of the market, sometimes increasing, sometimes narrowing, the distance between them.

In April 2018 both sectors had practically the same PER, around 12.5. Since then there has been an extreme relative movement between them, with electricity companies getting more expensive and banks cheaper. Behind this movement lie the slowdown of the economy, the fall in inflation expectations, the delay in the rise of ECB interest rates and the fall in returns on bonds.

Now the PER for utilities is near its highest level in recent years and that of the banks in minimums. If the indications of cyclical recovery in the economy which have been seen in recent weeks are consolidated, we should expect a move from defensive sectors towards cyclical sectors in the next few months, which would correct, at least partially, the extreme movement in the opposite direction we have seen in recent months.

The movement of European banks from the Great Recession of 2008-9 has been developed in a broad lateral range, as can be seen in the graph. The downward phases in 2011-2012 and 2015-16 coincided with strong recessions in profits. The last downward phase in 2018, however, cannot be explained by a significant fall in profits, but has rather been an adjustment of valuations because a stagnation in profits in the next few years has been discounted.

 

We believe that the current extreme pessimism of the market is excessive, both on valuations and growth forecasts, which leaves a margin for significant recovery in the next few months, although it will remain within their long term lateral movement.

The correction of the Ibex since 2017 has also been much greater than would be justified with the adjustment to the fall in profits in the last months of 2018.