Banks likely to outperform as Capex drives loan growth

Certainly in the UK, as the above chart, we can seen that since 1980, gross fixed capital formation has been significantly correlated with loan growth. Given today’s levels of capacity utilisation are near all-time highs and intentions for investment in the UK are also near all time highs, UK Capex is likely to pick up. This should in turn drive up loan demand, and correspondingly loan growth, therefore supporting earnings for the UK banking sector.

Similarly in the US, we find a significant relationship between the pace of Gross Fixed Capital Formation and loan growth. A robust pick-up in Capex, as signalled by the Philly Fed survey, which we highlighted previously, could correspondingly see loan demand pick up. This could help US banks that have, despite the cyclical economic recovery, lagged the rally in stock markets since 2009, finally outperform.

Even in the euro area, loan growth could start to improve soon. Historically the results of the ECB’s bank lending survey have led actual lending data by 9 months. Based on this lending in the EU should recover. The views of our European banks analysts in Could Lending Trends Improve in 2014? 23 April, 2014, corroborate ours.

They highlight that IBES consensus currently expects annual revenue growth of just 3% from the European banks sector over the next three years. This is very low as the sector has grown revenues faster than this around three-quarters of the time since1980. Therefore if our thesis of better loan growth does come through, consensus expectations for revenues are likely to be too low.

The final point we would highlight is that the corollary to the pick-up in corporate investment, as has been the case in the past, is that M&A volumes should pick up as well. M&A, similar to CAPEX, has been conspicuous by its absence so far in the recovery. However, as we highlighted in Bid-Up, 1 May 2014, M&A volumes have picked up in 2014.

We think, at the margin, the greater volume of M&A deals is likely to be supportive of revenues for investment banks. Thus, driven by a pick up in corporate activity, and the pick up in loan growth, we reiterate our overweight stance on banks.