In August, US group ValueAct announced a $1.1bn stake in Morgan Stanley. Yet the notorious boardroom activist had no plans to shake up management, no beef with strategy at the investment bank. The stock, it said, was simply cheap.
Mere months later an investment that had seemed brave at the time is worth $1.8bn. ValueAct’s gain is just one of the more striking examples of an extreme swing in attitudes towards bank stocks in a year of financial upheaval.
It had started disastrously for banks. By mid-February, US financial stocks in the S&P 500 had fallen 18 per cent, and Europe’s equivalent, the Euro Stoxx banks index, dropped even further.
Banks, the argument went, were caught in straitjackets of regulation, and more fines for previous bad behaviour loomed. As proxies for the health of economies, bank stocks reacted to each twist in a year of political drama and, making matters worse, low interest rates sapped profitability from the very act of lending.
But it was not just Morgan Stanley that bounced back. Banking equity indices in Japan, Europe and the US have all recorded double-digit gains over the second half of the year.
1. The Portuguese central bank imposes losses on Novo Banco bonds, markets react negatively
2. Widespread fears over Europe’s banks trigger a collapse in share and bond prices
3. UK and European banks plunge after the Brexit vote
4. Deutsche Bank fears reach a head as its shares hits three-decade low
5. Monte dei Paschi struggles to attract capital through its private sector solution
Even in Europe, where Italy is poised to recapitalise the country’s oldest bank after Monte dei Paschi failed to raise fresh capital from private investors, the Euro Stoxx banks index is still more than 40 per cent higher than at the end of June.
“The environment is one that’s flipped from the beginning of the year,” says Lloyd Harris, an investor at Old Mutual.
So what explains the reversal in fortunes, and what does it mean for the year ahead?
According to investors, one of the most important causes for optimism is the prospect of higher interest rates as policy gears are seen switching from monetary to fiscal measures in the coming year. Rising long-term bond yields help banks by boosting their net interest margin — the difference between the rates on their borrowing and lending.
“Three, six months ago my fear in Europe was very loose monetary policy synchronised in the US and Japan. In my view this was a trap, which could have ended very, very badly,” says Renaud Champion, an investor for La Francaise GIS.
“Fast-forward six months, you have the Fed and the US normalising interest rate policy and the market is taking that very, very well,” he adds.
US Treasury yields have risen sharply in recent months, a shift which accelerated after Donald Trump’s election as US president. In July, the 10-year yield traded below 1.4 per cent; it is now over 2.5 per cent.
Investors have also become more confident about the interplay between their interests and those of regulators. A further worry back in February centred on “coco” bonds, the riskiest form of bank debt created by regulators to offer flexibility in times of stress.
A debate about the health of Deutsche Bank highlighted confusion about rules governing when a bank must halt coupon payments. As prices for many such bonds — also known as additional tier one capital (AT1) — approached 70 cents on the dollar, stock market investors became nervous.
“Equities fed into AT1s, and then AT1 weakness, particularly Deutsche Bank, fed back into equities,” says Mr Harris.
Clarification from the ECB followed, and with no missed coupons from major banks, a return of confidence in the acronymic securities prompted a rebound in the iBoxx coco bond index of more than 20 per cent since mid-February.
Some investors are also optimistic the message to banks may be changing. “Years ago regulators used to say we’d like banks to make more loans to the real economy but at the same time we’d like them to strengthen their capital and liquidity,” says Sam Theodore, head of financials at Scope ratings.
“It’s like the old St Augustine adage — give me chastity but not yet,” he adds. “Now they have plenty of chastity on the regulatory side, it’s time to start making more money.”
Still, investors wary of banks remain in good company. In late September, Tidjane Thiam, chief executive of Credit Suisse, said European banks are “not really investable”. In the same month, Mario Draghi, president of the European Central Bank, said the continent had too many of them.
A state rescue for Monte dei Paschi could yet signal a need for intervention at several smaller Italian banks to resolve lingering problems of bad debts.
The bloodless verdict of the market also remains sceptical in areas where rates are lowest. In Japan, the banking sector is trading at a price-to-book ratio of just 0.65. In the US by contrast, where rates have risen, S&P 500 level 1 financials are estimated to end the year at 3.01.
European banks are on course to be worth 0.72 times analyst estimates for the book value of their assets at the end of 2016. For all the share price movement, the valuation is less generous than it was a year ago, at 0.74.
It perhaps reflects an assessment not of disaster or crisis, which prompted much of the volatility in bank shares in 2016, but rather a painful process of adjusting to a world of diminished prospects.
“I don’t think banks will get to pre-crisis profitability levels,” says Mr Harris. “I don’t think we should ever expect them to.”