UBS | With a rise in the Fed funds rate looking imminent, and given last week’s ECB QE extension, ascertaining how diverging interest rate policies could impact bank fundamentals will be key to helping investors identify winners and losers among global banks in 2016, in our view. Other critical questions for the sector next year include: has regulatory risk peaked; will an inflection in loan growth drive revenues in Europe; and is there an NPL crisis in emerging markets?
Fundamental challenges to persist but we see pockets of optimism
The fundamental outlook f or banks remains challenging, given sluggish loan growth, a mixed margin outlook and a varied asset quality picture, with further potential risk to earnings (especially given late – cycle characteristics in emerging markets). That said, there are pockets of optimism such as a potential NIM inflection in the US, a pick – up in credit demand in Europe, and early signs of regulatory pragmatism, notably in the US.
The market appears to be pricing in a c5% fall in earnings next year
The market remains sceptical about the sector’s earnings outlook for next year: based on 1 – year forward PE multiples, consensus is expecting a c5% fall in earnings to get back to long – run average valuations. We think global banks are currently fairly priced at 9.8x 2016E PE and 1.0x PBV, versus a sector ROE of 11.5%, and would need to see evidence of positive earnings momentum to become more constructive (we have cut our 2016 EPS estimates for global banks by 8.3% year -to-date).
Overweight US/UK; upgrade Australia; underweight emerging markets
We reiterate our overweight stance on US banks as they move closer to an inflection in margins. We are neutral in Europe (ex – UK) with a clear preference for banks in the UK and Benelux. We upgrade Australia to neutral (from underweight) given an i mproved operating outlook and more supportive valuations, but remain underweight emerging markets reflecting ongoing external risks, disappointing macro growth trends and deteriorating sector fundamentals.