Foreign Banks Stock Outlook - January 2018

The key short-term concern for foreign banks with significant U.S. operations is the impact of the recent tax overhaul. Similar to the domestic banks, these are being forced to write down the value of the tax credits they realized for incurring losses in the past, per a provision in the new tax law. These one-time charges will eat into their full-year 2017 profits. However, a lower U.S. corporate tax rate is expected to be positive for their bottom lines in the long run.

Barring this short-term concern, an uptick in this year’s global economic growth, projected by the World Bank, should instill further momentum in the foreign banking space, which ended 2017 with a solid recovery after being a laggard for a long time.

Particularly, the recovery witnessed by banks in advanced nations, fueled by accommodative monetary policy and fiscal stimulus of the central banks, could be self-reinforcing in the quarters ahead. While the central banks gearing up to raise interest rates is a downside to the sustainability of economic growth, it could be a blessing for banks as these thrive in higher rates.

The World Bank currently expects the global economy to grow 3.1% in 2018 after a 3% advancement last year. Though the expected growth rate looks moderate, it’s encouraging to note that the World Bank expects synchronized expansion across all major regions of the world.

Of course, buoyant financial markets will play a major role in driving the growth. And this makes the backdrop favorable for banks in key nations. Particularly, since the perking up of the economies of Japan and Eurozone — homes to the major foreign banks — is the key contributor to the growth, the foreign banking space should hold ample promise.

Financial results from the mega players for the quarters reported in 2017 were impressive. Profits were primarily driven by strong capital market results as global economic data held up well. Stability in the financial markets and optimism over global economic growth led to increased investor appetite for trading activity as well.

A measurable progress on overcoming the setback that most major economies were witnessing for quite some time is making investors increasingly optimistic. This, coupled with expectations of improving profit margins with some economies nearing the turning points of their monetary policy cycles and increasing demand from relatively less levered consumers and businesses, has helped foreign bank stocks leave the broader market behind over the past two years.

This is clearly evident from the Zacks Foreign Banks Industry’s rally of 62.9% in two years’ time versus the S&P 500’s 50.8% growth.

Before we delve a little deeper into the industry’s current backdrop and assess its prospects, let’s take a look at why it’s worth paying more premium for the stocks in the industry.

Foreign Banks Still Have Upside Left

While the industry has outperformed the broader market over the past two years, there is still a value-oriented path ahead. Looking at the industry’s price-to-book ratio, which is the best multiple for valuing banks because of large variations in their earnings results from one quarter to the next, investors might still want to pay more.

The industry currently has a trailing 12 month P/B ratio of 1.67 — the highest level in the past two years. When compared with the median level of 1.37 over that period, any further upside potential looks unlikely.

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