2020 has not been an easy year for bank investors, either relative to overall markets or other subsectors within the financial sector. As shown below, US banks have underperformed the broader market by 40% year to date, (even excluding tech the banks have underperformed a lot), a performance gap that is significantly wider than the lows of the global financial crisis (GFC) in March 2009.

European banks have been even greater laggards and are trading at record low valuations in terms of relative P/E versus the market, a 53% discount versus a long-term average of 27%, and at 0.4x price/book (P/B). To give some context on the relative weakness of banks in Europe, the market cap of eurozone banks is 38% of Australia and Canada’s banking sectors combined yet the eurozone GDP is nearly six times their size. Within Europe, UK banks have been in the eye of the storm, affected by political risk, in relation to both Brexit and US/Chinese tensions, as well as economic uncertainty related to COVID-19, and have fallen 50% YTD, underperforming their European peers. HSBC is now trading at a lower P/B multiple than in both the global and Asian financial crises.

The myriad of different issues potentially driving these concerns include lower rates forever, fears over the asset quality outlook, last crisis memories, dividend restrictions, fintech challengers, political risk ahead of the US election, Brexit and so on. Frighteningly, the list is long for investors like us, but the issue is how valid they are.

Here, we will focus on the issue of bank balance sheets and fears over a potential asset quality crisis. In a subsequent commentary, we will look at whether the current environment has weakened their structural positioning and long-term profitability.

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