Zacks Industry Outlook Highlights: Barclays, Deutsche Bank, Mitsubishi UFJ Financial Group, Mizuho Financial Group And Sumitomo Mitsui Financial Group

For Immediate Release

Chicago, IL – May 17, 2017 – Today, Zacks Equity Research discusses the Industry: Foreign Banks, including Barclays (LON:BARC) (NYSE: BCS – Free Report ), Deutsche Bank (NYSE: DB – Free Report ), Mitsubishi UFJ Financial Group, Inc. (NYSE: MTU – Free Report ), Mizuho Financial Group, Inc. (NYSE: MFG – Free Report ) and Sumitomo Mitsui Financial Group, Inc. (NYSE: SMFG – Free Report ).

Industry: Foreign Banks

Link: https://www.zacks.com/commentary/114163/foreign-banks-stock-outlook---may-2017

The year started well for foreign banks, as evident from the impressive January-March quarter financial performance by the mega players that have reported so far. Profits were primarily driven by strong capital market results as global economic data held up well. Stability in the financial markets and optimism over global economic growth led to increased investor appetite for trading activity as well.

With the International Monetary Fund (IMF) raising its global economic growth outlook last month and buoyancy in the U.S. and emerging markets, foreign banks’ prospects for the upcoming quarters are even better.

A measurable progress on overcoming the setback that most of the major economies were witnessing for quite some time is making investors increasingly optimistic. This, coupled with the expectation of improving profit margins with some economies nearing the turning points of their monetary policy cycles and increasing demand from relatively less levered consumers and businesses has helped foreign bank stocks leave the broader market behind this year.

This is clearly evident from the Zacks categorized Banks-Foreign industry’s year-to-date rally of 9.8% versus the 7.1% gain of the S&P 500.

Before we delve a little deeper into the industry’s current backdrop and assess its prospects, let’s take a look at whether it’s worth paying more premium for the stocks in the industry.

Are Foreign Bank Stocks Still Undervalued?

While the industry has outperformed the broader market so far this year, there is still a value-oriented path ahead. Looking at the industry’s price-to-book ratio, which is the best multiple for valuing banks because of large variations in their earnings results from one quarter to the next, investors might still want to pay more.

The industry currently has a trailing 12 month P/B ratio of 1.71 – close to the highest level of 1.73 since the beginning of the year. When compared with the median level of 1.42 over that period, any further upside potential looks unlikely.

However, the space actually compares pretty favorably with the market at large, as the trailing 12-month P/B for the S&P 500 is at 3.56 and the median level is 3.52.

As finance stocks typically have a lower P/B ratio, comparing foreign banks with the S&P 500 may not make sense to many value investors. But comparing the group’s P/B ratio with that of its border sector ensures that the group is undervalued. Zacks categorized Finance sector’s trailing 12-month P/B ratio of 2.47 and the median level of 2.32 over the same period are way above the Banks-Foreign industry’s respective ratios.

Overall, while the valuation from a P/B perspective looks stretched when compared with the industry’s own range in the time period, its lower-than-market and lower-than-sector positioning calls for a decent upside in the quarters ahead.

The group’s Zacks Industry Rank confirms this view. This 65-company industry carries a Zacks Industry Rank of #86, which places it at the top 34% of over 250 Zacks classified industries. Our back-testing shows that the top 50% of the Zacks ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Expected Economic Growth to Bolster Profitability

The IMF sounded optimistic about global economic growth in 2017 and 2018. Last month, the fund predicted that the economy will grow 3.5% in 2017 and 3.6% in 2018 versus 3.1% in 2016. This pickup is expected to stem from a rebound in investment, manufacturing and trade across economies.

The IMF expects continued policy support in China, coupled with fiscal expansion and deregulation in the U.S., to keep financial markets buoyant. The advanced economies, in particular, are likely to witness decent growth. This will undoubtedly get reflected in the performance of banks in these regions. Moreover, the increasing possibility of the European Union nearing the end of its ultra-low interest rate environment based on economic improvement raises optimism about its banks’ top-line growth.

While a faster-than-expected pace of interest rate hike in the U.S. and a strengthening dollar will lead to capital outflow and make credit expensive for emerging and developing economies, a recovery in prices for commodities, which many of these economies export, will help them to grow moderately. Consequently, banking activities in these economies should not weaken. According to the IMF, “Stronger activity and expectations of more robust global demand, coupled with agreed restrictions on oil supply, have helped commodity prices recover from their troughs in early 2016.”

Prospects Look Up for Banks in Key Nations

Despite the French election relief rally and investors’ optimism over economic growth and earnings improvement, shares of the major European banks – including Barclays (NYSE: BCS – Free Report ), Deutsche Bank (NYSE: DB – Free Report ) and Credit Suisse (SIX:CSGN) – have underperformed their U.S. counterparts so far this year, as the key interest rates are still ultra-low.

Perked up capital market activity, better business in emerging market operations and support from a trading boom in the U.S. have helped many European banks report improved results in the January-March quarter, overcoming the Brexit gloom. While Deutsche Bank, Royal Bank of Scotland (LON:RBS) and Barclays witnessed year-over-year improvement in earnings, Credit Suisse returned to profit.

While historic low key interest rates will mar top-line growth and the pain with bad assets on balance sheets will continue, favorable capital market activity and reducing non-core losses should help European banks to show some bottom-line improvement in the quarters ahead.

The prospects of the banks in Japan remain uncertain with the central bank leaving its interest rate unchanged at negative 0.1% at its Mar 2017 meeting and not hinting at future rate rises. The struggle to dodge deflation will likely keep its monetary policy loose for some time. While the economy will keep growing moderately, it’s unlikely to materially benefit the banking system by offsetting the damage caused by the negative rate environment.

Shares of the top three Japanese banks by assets -- Mitsubishi UFJ Financial Group, Inc. (NYSE: MTU – Free Report ), Mizuho Financial Group, Inc. (NYSE: MFG – Free Report ) and Sumitomo Mitsui Financial Group, Inc. (NYSE: SMFG – Free Report ) – have underperformed the S&P 500’s 7.1% gain so far this year. While Mitsubishi UFJ and Mizuho Financial have gained 3.4% and 2.2%, respectively, Sumitomo Mitsui has lost 4.3%.

As the rising rate environment in the U.S. could create growth headwinds for China due to significant capital outflow from the economy, the Chinese central bank has been raising benchmark rates on its open market operation facilities in an effort to conserve foreign reserves. It also indicates steadiness in the economy. So the rate environment is not so unfavorable for its banks. However, the economy’s credit vulnerability could be risky for its banking system.

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