European banking stocks head lower as Deutsche Bank drops recommendation to sell

ECB's Draghi: Monetary support still necessary
ECB's Draghi: Monetary support still necessary

Deutsche Bank has lowered its recommendation on European banks to sell, pointing to fading regional growth momentum as a headwind for the sector in coming months.

The level of growth implied by strong recent Purchasing Managers' Index (PMI) data is around 3 percent which far exceeds Deutsche Bank research's internal forecast of 1.8 percent, according to analysts at the German bank in a note published Tuesday.

"If PMIs fade back to the levels consistent with our economists' projections (at around 53), this would imply PMI momentum (i.e. the six-month change in PMIs) turning negative over the coming months," said the analysts.

"Banks are among the sectors most sensitive to swings in euro area PMI momentum and tend to underperform when it turns negative," added the note, observing that current valuation levels do not offer any further support to the sector's stocks given their ramp up in price in recent months.

How political news, US data will shake up markets this week
How political news, US data will shake up markets this week

However, there is some respite for banks coming later this year, say the research's authors, both on account of changes in data and central bank policies.

"We expect PMI momentum to trough later in the year, at which point we will be looking to turn more positive on banks, especially given that our sector analysts see upside for the sector over the next 12 months (as a function of the expected interest rate normalization)," continued the note.

The banking sector was dragging the European indices lower on Tuesday morning with the Eurostoxx 600 banking index down by around 1.5 percent by 12:30 p.m. London time. UBS and Deutsche Bank were among the biggest losers in the session's early trade.

Deutsche Bank headquarters
Photo by Hannelore Foerster

Comments from European Central Bank (ECB) chief Mario Draghi on Monday revealing his wish to continue with a monetary policy easing bias in the coming months pulled banks lower as the punitive low yield environment looked set to persist for longer.

The banks have actually been hit by a "double whammy" of Mr. Draghi's remarks and by virtue of being a cyclical trade, said Lothar Mentel, chief investment officer (CIO) at Tatton Investment Management, on CNBC's Squawk Box on Tuesday.

"If you buy Europe and if you believe in the story of the recovery and the strong economic momentum, it's best to go into banks - so that (this session's selling momentum) tells me that the markets are starting to be a bit more cautious about that perspective," opined Mentel.

Yet while the global equity market is quite fully valued, Europe – and indeed financials - do retain some attraction versus other listed company investment options, according to Joe Prendergast, head of financial market analysis at Credit Suisse.

"Europe is still in an earlier part of the cycle, valuation is that little bit better, the monetary cycle is not fully priced in and could, overtime, evolve in a more constructive way. So I think you can still highlight the financials as offering some potential," posited Prendergast on CNBC's Squawk Box on Tuesday.

"But Europe in particular, which has a heavy weight in financials - Europe is the region which stands out to us as most attractive," he concluded.

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