European Banks: Will They Drag Down Global Markets Again?

| About: Credit Suisse (CS)

Summary

One of the major drags on global stock markets early in 2016 were European banks.

After a rally starting in mid-February, some of these banks are back down to their February lows.

Some European banks are actually selling at prices below their Credit Crisis lows in 2009.

Contagion from problem with European banks can impact their entire global financial system.

Among stocks in the U.S. market, the Financial Sector was in constant competition with Healthcare for the worst performer status in the first quarter of 2016. Big bank stocks were weak in the U.S., but their problems paled in comparison to banks in Europe. Problems with banks across the Atlantic were one of two major factors behind the global stock selloff the first six weeks of the year (weakness in the Chinese economy was the other one). While European banks began rallying around mid-February along with the overall market, they are now headed back down again. All stock investors should be paying attention to this because it may drag down stocks everywhere.

By mid-February, the Bank Index of the Stoxx Europe 600 was down 22% (Deutsche Bank (NYSE:DB) was down 32% and Credit Suisse (NYSE:CS) 38%) and this helped drag down European stock markets 12%. Bank stocks fell for seven straight weeks, the longest decline since a ten-week drop in 2008. Some have since returned to their previous lows as can be seen below in the 6-month daily price chart for Deutsche Bank. UniCredit (UCG) and Credit Suisse have also lost their entire rally. HSBC (NYSE:HSBC) and Royal Bank of Scotland (NYSE:RBS) are now trading at a lower low than they did in February.

Six-Month Price History of Deutsche Bank

The rally that followed should be viewed as a relief rally from a severely oversold condition. None of the problems facing European banks are likely to go away anytime soon. The two major ones are: large amounts of non-performing debt and negative rates from central banks on the continent (this is not to say that regulatory issues and global economic problems aren't impacting bank financial performance as well). The seriousness and duration of the problems facing European banks can be seen in their long-term stock prices. HSBC and Lloyd's Banking Group (NYSE:LYG) are trading around their Credit Crisis lows from 2009. Deutsche Bank, Credit Suisse, UniCredit, and Banco Santander (NYSE:SAN) are trading BELOW their Credit Crisis lows. The chart below shows stock price losses during the last ten years for these banks. Deutsche bank is the line in black.

Four European Banks Trading Below Their Credit Crisis Lows: CS, DB, UCG, SAN

Non-performing loans held by European banks were estimated by the IMF to be $1.13 million at the end of 2014. There are proposals to settle this issue through bail-ins of bond holders. However, in some European countries, local retail investors own a substantial amount of these bonds, so it may not be politically possible to implement this. Italy is ground zero for this problem with 18% of bank loans estimated to be non-performing. Retail investors there own approximately €200 billion of bank bonds, equivalent to 12% of GDP.

As for negative rates, these are pervasive in Europe. At least ten governmental entities have issued bonds with below zero yields and central banks in Scandinavia and Switzerland (not part of the Eurozone) and the ECB have negative rate policies. The ECB lowered its deposit rate from minus 0.3% to minus 0.4% at its meeting in March. This is acting as an indirect tax on bank reserves, which policy makers have forced banks to increase previously to prevent another financial crisis.

Recent and long-term price declines indicate that most major European banks are dangerous to hold and certainly shouldn't be bought in the near future. Traders looking for short candidates might want to consider these stocks. Conservative investors should consider them off limits until there is evidence that a major bottom has been put in. All investors should watch to see if financial contagion spreads from Europe to the rest of the global monetary system.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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