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European banks have never traded this cheap relative to U.S. banks, according to an equity research team at Citi, who have turned bullish on the beaten-down sector.
On Sept. 19, Citi declared that European banks were "the world's biggest contrarian trade" but remained neutral with its outlook. However, on Thursday a new note from the bank said it was now "overweight" on the sector, suggesting that investor positioning is very light.
"Euro area, Europe ex-U.K. and U.K. banks are among the worst five performing region/sector combinations in the last 10 years out of 285 we track," the team, led by Jonathan Stubbs, said in the note. "European banks have been the lightning rod for all post-GFC (global financial crisis) macro risk," it added.
But it saw those risks declining with quantitative easing continuing, lower sovereign risk, lower bank risk, benign commodity markets and more "synchronized" growth across the globe. It acknowledged headwinds, but explained there were also signs of improvement such as loan growth and improving returns.
U.S. banks have been busy rebuilding their balance sheets after the 2008 crisis but their European counterparts have been slow off the mark. Deutsche Bank has borne the brunt of the recent selling due to capital concerns following a proposed $14 billion settlement from the U.S. Department of Justice.
Deutsche shares were trading at around 102 euros ($114) in 2007, but are currently lingering around 10 euros and are down 45 percent so far this year. The region is still dealing with fragile growth and stubbornly high unemployment and is still being assisted by aggressive monetary policy from the European Central Bank.
Citi did not mention Deutsche Bank but explained that European banks with exposure to emerging markets could bounce bank, as well as Italian banks. Its top picks are stocks such as BBVA, Standard Chartered, Danske, KBC, Intesa, BNP, and ING.
The banking sector in Europe is down some 22 percent so far this year and few analysts are making similar sounds to this contrarian call from Citi. However, Valentijn van Nieuwenhuijzen, head of multi-asset at NN Investment Partners, is another who sees the region's financial stocks as an opportunity, as well U.S. banks.
"They have not been very loved so far this year ... They are seen as a value trap and that is something you should always be very cautious about," he told CNBC Thursday. He said investors should look for favorable upticks in global debt yields, which tends to help banks generate some sort of return.