Amundi Investment Talks – Market nervous on Deutsche Bank, but fundamentals of European banks are solid

– Uncertainty in markets continued at the end of last week, with additional volatility in the banking sector and Deutsche Bank experiencing pressure in particular. In an attempt to calm markets down, ECB President Christine Lagarde reiterated the strength of the European banking sector, while German Chancellor Scholz also said that Deutsche Bank appears profitable and there is no reason to worry.

– Markets appear to be mostly driven by rising recession fears at present, following a strong start to the year amid excessive complacency; however, we see little change in terms of the fundamentals in comparison to previous weeks. Bank stocks are not the only ones being heavily impacted. Energy and basic resources stocks, as well as oil prices, have also taken a hit. On the opposite side, investors have moved towards gold, money markets and government bonds in a search for safety.

– While we see credit growth continuing to decline, we do not expect to see a credit crunch in Europe. Importantly, European corporates and households are not carrying excessive leverage. European banks have plentiful capital and liquidity to support the real economy, so we expect them to remain open for business and to continue extending loans to credit-worthy customers. 

– European banks’ fundamentals are solid and banks, including Deutsche Bank, have capital and liquidity levels above regulatory requirements. We also note that the ECB and other central banks have provided explicit reassurance that they stand ready to address any liquidity shortfalls in the system. In addition, all European regulators have reassured bank investors that they would respect the capital hierarchy in the event of any resolution or merger, confirming that the Credit Suisse episode was an exception. Within the sector, we continue to prefer retail banks with stable, diversified deposit bases that are able to generate high levels of profitability and cover their cost of capital. In a higher interest rate environment, where the market is more discerning about business models, the ability to deliver sustainable profits will be increasingly important.

– In this uncertain backdrop, as markets reassess the economic outlook, we reiterate the need to maintain a cautious investment stance. Investors should seek a balanced approach with a focus on government bonds, which are once again acting as an equity diversifier, and gold. In equities, having a tilt towards quality is key in the current environment. Quality stocks are those with low leverage, reliable and stable earnings and strong balance sheets. Cyclical areas (such as banks, energy and basic materials) will likely continue to be exposed to a weak economic outlook and therefore remain under pressure until more clarity is re-gained. This will open entry opportunities later in the year.