In a market of fewer and fewer bright spots, the recent sell-off in bank ETFs offers an exciting tactical asset allocation play for investors willing to take on the contagion risk.
The events of the last few weeks have been nothing short of dramatic. Just two weeks ago, markets were pricing in the possibility of the Federal Reserve hiking interest rates to 6% after chair Jerome Powell delivered hawkish comments at the Senate Banking Committee.
However, this was stopped short in its tracks following the collapse of Silicon Valley Bank (SVB) in the US, sparking fears of contagion risk throughout the banking system. In response, the Fed quickly stepped in as the lender of last resort by covering SVB clients’ funds.
Market nerves did not stop there with Credit Suisse the next to suffer a liquidity crunch. The Swiss National Bank (SNB) initially loaned the beleaguered Swiss bank $54bn but that did little to ease the panic.
In response, the SNB and Swiss regulator FINMA brokered a deal between UBS and Credit Suisse last weekend which would see UBS acquire its rival for $3.25bn.
After markets appeared to calm, a fresh sell-off occurred last Friday when contagion fears sent the credit default swaps (CDSs) of European banks soaring and the share prices tumbling.
As a result, bank ETFs have been among the worst-performing strategies in Europe over the past month with the iShares S&P US Banks UCITS ETF (BNKS) plummeting as much as 29%.
However, there is evidence to suggest bank ETFs have fallen too far and are now trading at attractive levels.
As the sage of Omaha Warren Buffett said: “Be fearful when others are greedy and be greedy when others are fearful.”
This appears to be one of those moments. To suggest the collapse of SVB and UBS’s acquisition of Credit Suisse are isolated incidences would be a step too far, however, there are clear reasons why the two lenders have folded.
Taking SVB first, management’s decision to invest in long-duration US Treasuries without hedging interest rate risk was misguided – to put it mildly – while Credit Suisse has been mired by scandal after scandal which has driven its share price down 98% since highs in 2007.
Furthermore, following the Global Financial Crisis (GFC) in 2008, banks, especially in the US, are better capitalised to cope with any shock to the system.
“We do not see a repeat of 2008 when the downfall of Lehman Brothers spiralled into a GFC,” the BlackRock Investment Institute said. “The Swiss bank’s woes have long been known, banking regulations are much stricter and the bank’s assets are of higher quality.”
“There are much higher liquidity ratios at banks today,” Myles Bradshaw, head of global aggregate strategies at JP Morgan Asset Management, added. “They learned their lessons. There are many differences that give me confidence this is not going to be a repeat of the GFC.”
Add to this the willingness of central banks to be the lender of last resort and this leaves bank ETFs with plenty of scope for outperformance over the next six months.