European financial stocks are now looking more attractive during a “sweet spot” between market fears about a euro zone recession and liquidity coming into the European banking system, Bill O'Neill, chief investment officer of Merrill Lynch Wealth Management for EMEA, told CNBC Monday.
“There are a lot of dangers, but correlations are still very positive. Given how low valuations still are, you don’t really need to be ambitious in terms of leverage to get a decent turn,” he said.
The Stoxx Europe 600 Banks Index has risen by 17 percent this year, after falling by 33 percent in 2011.
Optimism has been spurred by the European Central Bank’s long-term refinancing operation (LTRO), launched in December, which has injected much-needed liquidity into the banking system.
“At the bare minimum, this removed the risk of a funding crisis for European banks,” Kit Juckes, global head of Foreign Exchange Strategy at Societe Generale, told CNBC Monday. “Don’t go in all gung ho, but we can go higher than this.”
Another LTRO, which allows banks to borrow at cheaper rates, is expected later this month.
“The market is now anticipating further dollops of liquidity from the central banks, with obviously news this Thursday from the UK, but the big one is the second LTRO, and the market thinks it’s going to be a big number,” O’Neill said. “There will be a drawdown into risk assets if we get the fundamental improvements.”
The LTRO results do not appear to have trickled down to the real economy yet, with a quarter of banks expected to toughen their lending rules in the coming months, according to the ECB’s quarterly Bank Lending Survey.
“Every CEO of every bank that can do that (borrow) heaves a massive sigh of relief and can get on with the business of being a banker. That does slowly change behavior,” said Juckes.
However, the bond yields of peripheral euro zone economies have fallen after reaching dangerously high levels last year.
"Bond portfolio managers have seen the Italian, French, Spanish markets move up quite strongly. They’re at benchmark risk now and they have to move in terms of making a commitment. Somebody is buying European peripheral debt when Italian bond yields are below 6,” O’Neill said.