As everyone knows, the ECB… finally (!)… announced open ended quantitative easing, the details of which are as follows:

(a) amount of €60 bln a month until at least September 2016 (or ~€1.0 trillion) according to the capital key, which means purchases are roughly apportioned by GDP of each country. This amount includes existing ABS and covered bonds.

6%+ yield

(b) assets include government securities, debt securities issued by European institutions, and private sector bonds

(c) 20/80 loss sharing between ECB/national central bank (as a concession to the Germans)

(d) begins in March, excluding Greece (until at least July)

There are a lot of moving parts to this announcement, but the bottom line is that the ECB is determined to get the size of its balance sheet back to 2012 levels and provide material liquidity to the market. Broadly speaking, this program/announcement is above market expectations.

What does this mean? As we have said many times, we don’t see it as a panacea, but it will certainly help, with its biggest impact being: (i) to push longer term rates down and/or hold them down (since they had already moved down in anticipation) improving debt sustainability, (ii) to contribute/preserve a significant decline in the euro (which is down over 10% on a trade-weighted basis). Together, both should be supportive of GDP in the coming quarters (along with falling energy prices). However – for bank investors – we think the biggest impact is to help boost confidence in the sector, in particular, giving them greater confidence in their macro thesis allowing multiples to rise (as they believe the ECB will “do what it takes” to avoid deflation/recession). We believe this was a key component to the U.S. bank rally over the past few years, where the GDP/deflation news flow basically matched what you see in Europe today. Also, expansive monetary policy is generally supportive of “risk assets”, including banks.

But to be clear; the level of QE is not going to directly impact earnings estimates, which continue to recover/normalize at a rapid rate (Q4 might be lumpy, but the trend is very powerful), driven primarily by falling loan losses, and lower expenses. Capital levels are very solid, and importantly – from a portfolio perspective – dilution risk is very low. And, obviously, valuations remain very cheap, with the HCP European Bank Fund LP (HCP-EBF) trading at around 0.8x TBV.

For the following reasons, we continue to see the sector as offering a very good risk-reward:

(a) European banks are a gigantic part of the equity markets (recovered market cap > $4 trillion) and it makes sense to have exposure given low valuations,

(b) European banks are growing earnings faster than any banking system that we know of globally (or any part of the global financials, for that matter),

(c) Valuations are compelling at 0.8x TBV (U.S. large-caps at ~1.5x; Canadian banks ~2.5x), and

(d) Canadian and U.S. banks are operating at “normal” levels of profitability, and therefore, lack credit cyclicality offered by European banks.


A final thought: it is extraordinarily difficult to generalize Europe, which the financial press does relentlessly. There really is no “Europe” – per se, insofar as it is NOT a region of significant homogeneity that broad generalizations can be easily made. Europe consists of 25+ notable countries (and over 40 overall), with different economies, cultures, languages, governance, bankruptcy law (surprisingly important), economic productivity, central banks, and currencies. Unless they are referring to location, virtually every time someone writes “Europe is <insert description>”, you can be almost certain it is an over-generalization. 

To wit: when you read, “Europe needs labour/fiscal reform“‎, what the author/journalist really means is, “the following countries accounting for ~30% of GDP need to reform: Italy (10% of GDP; trying), France (13%; not trying), Spain (6%; trying), Portugal (1%; trying), and Greece (1%; utterly broken country, trying, but too far behind)”.

What is not distinguished is the countries accounting for ~70% of GDP that do NOT need significant reform including: Germany and U.K. (~30% of GDP), and Sweden, Denmark, Austria, Turkey, Netherlands, Poland, Finland, and 10+ Central and Eastern European countries.  We are not trying to diminish the challenges facing many parts of the continent, only trying to give it the appropriate perspective/context. There is a hardly a single issue that applies to the entire region equally.

However, the bottom line is that Europe is a very large and incredibly diverse place to invest. And the HCP European Bank Fund LP (HCP-EBF) is working to capitalize on the opportunities across this wide spectrum. And, in our view, we believe the sector represents one of the most compelling cyclical opportunities in the global financials today.

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