GLOBAL EQUITY BULLETS | Wednesday, 22 May 2024

European Banks – Profits beat expectations, driving earnings and valuation higher
Last week brought the curtain down on another constructive set of quarterly earnings for the European bank sector. In 1Q24, reported profits beat consensus expectations by c.10% on average. A sustained benign risk backdrop supported ongoing low provision rates, but pre-provision profits were also a solid 5% ahead of market expectations as bank margins continue to benefit from the better interest rate environment and there are some early signs of improving momentum in non-interest income. The European bank sector has now entered its fourth year of outperformance (outperforming by >10% vs broader European market YTD), but we believe there is more to come over the medium-term as earnings revisions continue to do better; the relative and absolute discount vs history remains large despite the improved fundamentals; the yield attractions remain substantial (c.7.0% cash yield with buybacks worth an additional 3-4% on top).

US Banks – Debate on capital buffers
After months of intense industry push-back and debates among the US banking regulatory agencies on the initial Basel 3 Endgame proposal regarding capital levels, recent reporting indicates that regulators are planning to significantly lessen the amount of capital that the biggest banks would be mandated to hold to absorb against potential losses.  Initial estimates put the overall required increase in large bank capital levels at roughly 20%, whereas expectations are now for a reduction to about half that amount on average.  This change would result in a capital benefit of more than $100 billion for the six largest banks alone and puts them near or above pro forma required minimums as of today, while any new rules will not start to be phased-in until the second half of 2025 (or later).  While much uncertainty remains regarding the final revisions and timing, this is a favourable development for the banks and could lead to greater than expected capital return.

The tariff tightrope – Strategic policy or tactic ploy?  
The US has recently levied tariffs on imports from China’s emerging industries, including a 100% tariff (up from 25%) on Chinese electric vehicles (EV), as well as raising tariffs on other key industries including semiconductors, solar, and batteries. The move, which comes as the US continues to hype the so-called Chinese “overcapacity” in green products, is facing more challenges and questions while increasing the volatility of many related EV stocks.

Putting the automobile market into context, China is the largest automobile market worldwide, both in terms of demand and supply with approximately 29 million units in 2023 out of >90m global production (ca 30% share). China also ranks first in the world in both quantity and value of automobile exports, with 5.2 million units in 2023, representing 1.2% of China’s global exports.

While someone might consider this move as a defensive one, as China’s manufacturing competitiveness far exceeds that of the US, we believe it has a more political goal as Biden aims to bolster his image as being tougher and smarter on China than former President Donald Trump. In fact, while the Biden administration aims to prevent a flood of cars made in China from hitting the U.S, current numbers demonstrate the impact is negligible for the American market: Chinese carmakers sold less than 20,000 EVs to the US in 2023, compared with 1.4 million EVs sold in the US in total.

Considering that US tariffs are basically symbolic, as they only affect 1.4% of the market, the key point here is if Europe will follow with any tariffs of its own. Chinese brands could reach over 180.000 volume in 2024, or ca 9% of the European EV market in 2023. This is more sizeable than in the US, thus making Chinese cars more expensive and limiting more affordable EVs for Europeans. It is crucial that a potential higher tariff is accompanied by a regulatory push to increase production of EVs, including electrification targets for company car fleets by 2030 – on top of the agreed 100% clean car goal in 2035. Moreover, Europe needs to consider that investments in lithium-ion batteries would be also at risk as cells manufactured in China are at least 20% cheaper than in Europe, and Chinese battery-makers are ahead on technology and supply chains. On this side, the US is also attracting battery investments through generous subsidies via the IRA, creating more supply chain security

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Algebris Investments’ Financial Equity and Global Equity Teams