Market review

Global financials were very strong over the month, rising by 6.8% as illustrated by the Trust’s benchmark index, the MSCI All Country World Financials Index, led by US and European financials rising 7.4% and 9.7% respectively while Asian financials lagged, up by only 3.0%.  Wider equity markets, which rose by 3.9%, were impacted by the news of DeepSeek’s much lower cost AI model which led to a selloff in technology shares. US banks’ earnings exceeded expectations. Revenues were higher than expected on the back of higher net interest income, due to better net interest margins and strong growth in capital market fees, while provisioning came in line with or better than expected, reflecting benign asset quality trends. Consequently, we saw positive earnings revisions for most US banks. Conversely, US insurers lagged the rally, in part as January renewals were weaker than expected, with pricing for property catastrophe reinsurance falling by around 8%, according to insurance broker Howdens. A number of companies also increased reserves on their casualty books as claims for previous years continue to trend higher than expected. Against that background, the Trust’s net asset value rose 6.3%, with holdings in BFF Bank and RenaissanceRe Holdings the main drag on performance.

Regulation

We see a reduction in regulation as a tailwind for the sector. Unsurprisingly, the topic was raised on US bank results calls. In response to a question on any likely impact on capital, Jeremy Barnum, the CFO of JPMorgan Chase, said: “I could go down some pretty deep rabbit holes speculating on all the different parts of the framework and how they could evolve. And I just don't really think that's productive right now. But let me make some attempt to answer your question. So backing off a second, if you read Jamie's [Jamie Dimon, CEO of JPMorgan Chase] quotes, they're very consistent with what we've been saying as a company for a long time, which is that all we want is a coherent, rational, holistically assessed regulatory framework that allows banks to do their job supporting the economy that isn't reflexively anti-bank. It doesn't default to the answer to every question being more of everything, more capital, more liquidity. It uses data and it balances the obvious goal that we all share of a safe and sound banking system with actually recognising that banks play a critical role in supporting growth.”

Similarly, the Chairman and CEO of Goldman Sachs, David Soloman, echoed those sentiments but also went on to discuss the lawsuit brought in December by the US banking industry against the Federal Reserve’s stress tests stating: “We have long been concerned that the lack of transparency and the Fed's current stress-testing creates uncertainty, and at times produces results we cannot understand, and which can lead to higher industry-wide borrowing costs, reduced market liquidity and inefficient capital allocations. For the industry, the bar to take this step was incredibly high. And while the Fed has announced that it's seeking to improve the stress test, the suit was filed to protect our rights. We believe it is our responsibility to continue to press for a more transparent regulatory process in order to foster a more efficient financial system that supports [the] growth and competitiveness of the US economy.”

US banks took out their 2022 highs at the end of last year with the election of Donald Trump and the expectation of the positive tailwinds this would lead to for the financial sector.

Further underpinning the change in tone from the new administration, in a statement on his appointment as the new Chairman of the Federal Deposit Insurance Corporation, one of the three main banking regulators in the US, stated that there would be a wholesale review of regulations to ensure the rules and approach would “promote a vibrant, growing economy”. He added that the bank merger approval process would be improved to ensure merger transactions that satisfy the Bank Merger Act are approved in a “timely way”. In February, Russell Vought, the Acting Head of the Consumer Financial Protection Bureau, was reported by the Wall Street Journal to have issued a notice to staff demanding they “cease all supervision and examination activities”, not to issue any proposed or final rules or guidance and to suspend the effective dates of rules not yet effective.

In a volte-face, the narrative in the UK appears to be shifting to reduce the burden on the financial sector with, for example, the Treasury stepping in to intervene in the motor finance Supreme Court appeal calling for any compensation to be proportionate to the losses suffered. After the month-end it was also confirmed that going forward claims management companies will have to pay a £250 fee for every claim they send to the Financial Ombudsman Service having previously had to pay nothing, leading to many spurious claims and costs to financial institutions. In Europe, where politicians are also belatedly falling over each other to highlight the need to respond to the lack of growth, the European Commission’s new financial services commissioner has said she wants the capital markets union to go ahead with a “coalition of the willing” rather than wait for all countries to agree.

Outlook

Against this background, the Trust is overweight US and European banks. US banks took out their 2022 highs at the end of last year with the election of Donald Trump and the expectation of the positive tailwinds this would lead to for the financial sector. Nevertheless, despite the improved sentiment, at the end of the month they traded on a P/E¹ ratio of 12x, below the levels they reached in 2017 and 2021 which cannot be said for the wider equity market. Commentary remains very constructive. For example, Morgan Stanely highlighted on its earnings call that “Depending on how you measure it, whether volume or unit, you see pipelines in M&A that are the highest in seven years. So that is really encouraging. Now some of this will be dependent on how things roll in the first couple of months of the incoming administration and how things feel on a cross-border basis but the pent-up activity that we’re seeing is starting to release.”

If US banks are inexpensive European banks remain on very low valuations, on a P/E ratio of 8.0x, well below levels they have reached over the past 10 years. Likely missed by many market participants, they have hit six-year relative highs against wider European equity markets and are still around 20% ahead of US banks in terms of performance since the eve of the pandemic, over 30% if one excludes the impact of the stronger US dollar against the euro over that period. Unsurprisingly, performance prior to that is still held back by the consequences of the European Central Bank’s policy of negative interest rates which it insisted incredulously at the time had “negligible effect on bank profitability”. The other missing ingredient for European banks for most of the past 15 years has been the lack of loan growth. The most recent European bank lending survey has been more positive, showing a steadily increasing pickup in the demand for mortgages since the end of 2022. With household debt-to-GDP ratios having fallen substantially over the past 10+ years, the ingredients are in place for them to continue to surprise positively.

1. P/E stands for price-to-earnings ratio, which relates a company's share price to its earnings per share.