Financial markets were strong in January, on growing optimism that peak inflation has been reached on both sides of the Atlantic and increased optimism of a soft landing on the back of lower energy prices. Against this, the Trust’s net asset value rose 3.6%, while our benchmark, the MSCI All Country World Financials Net Total Return Index, rose 5.4% , the lag due to our more defensive holdings in the insurance sector and a selloff in Indian financials on asset quality concerns related to the Adani Group.
US financials rose 5.8% over January, led by banks and diversified financials. US bank results came in better than expected, driven by stronger net interest income reflecting the impact that higher interest rates are having on net interest margins. Expenses came in line while provisioning was slightly higher than expected as banks built loan loss reserves. Wells Fargo, held by the Trust, reported a sharp fall in its legal reserves as it continues to get to grip with its legacy conduct-related issues.
Capital came in better than expected, in part reflecting the positive mark-to-market move in securities portfolios as bond yields fell over the fourth quarter leading to increased buyback expectations for this year. There has been a slight cut in earnings estimates for the large-cap banks on higher than previously modelled deposit costs but reassuringly management teams continued to increase loan loss reserves to capture a mild recession despite better than expected economic data.
Asian financials lagged during the month, rising by only 3.7%. There was continued momentum on China’s reopening leading to a strong recovery in Chinese financials, which rose 6.7%, and a broader rotation into North Asia and those economies with the strongest links to China. Economic data for China showed a rebound in January supported by a recovery in domestic demand as consumption picked up during the Spring Festival holiday.
However, in contrast, Indian financials were weak, with our holdings in HDFC Bank and IndusInd Bank the biggest drag on performance, after a short-seller released a report on Adani Group, a large Indian conglomerate, alleging fraud, stock price manipulation and lax financial controls. While the banking sector’s exposure to Adani group is relatively low, at around 0.6% or 0.3% of the loan books of private sector banks, having been reduced in recent years, the allegations raised broader concerns about corporate asset quality in India which will impact sentiment in the shorter term.
European financials were very strong in January, rising 10.1% led by the banking sector where the shift in the interest rate outlook has supported earnings expectations and a mild winter, falling gas prices and government support has reduced concerns that the energy crisis will lead to a material pick-up in loan loss provisioning. The first European banks to have reported fourth-quarter earnings have shown strong revenue trends, with net interest income rising 26% over the year on average and about 4% ahead of expectations, leading to further earnings upgrades.
The insurance sector lagged, reflecting the rotation back into risk. Nevertheless, outside a profit warning from Direct Line InsuranceGroup due to the cold weather snap in the UK in December and also higher claims in motor insurance, which is being seen in other countries as well, results were reassuring. Furthermore, the reinsurance sector benefited from the 1 January renewals which saw an average increase in reinsurance rates of 37%, according to Howdens, an insurance broker, which was much larger than expected.
Despite the positive tailwinds of the past two years, the sector continues to trade at an inexpensive forward price to earnings multiple.
During the month we added to our European bank exposure, purchasing a new holding in BNP Paribas while adding to holdings in CaixaBank and Nordea Bank. We also added to our holdings in Bank Rakyat Indonesia and Bank Central Asia, both Indonesian banks, as well as adding to AIA Group and Hong Kong Exchanges & Clearing which we see benefiting from the reopening of China. Against these we have slightly reduced holdings in a number of our insurance company holdings, albeit the net result was to increase gearing to 8.2%.
The elephant in the room remains whether we see a much sharper slowdown than markets are starting to imply or a soft landing that is starting to be priced in, mixed signals aside. Either way we remain constructive on the outlook. Despite the positive tailwinds of the past two years, the sector continues to trade at an inexpensive forward price to earnings multiple of 10.6x, a 33% discount to the 15.8x multiple for wider equity markets, as illustrated by the MSCI All Country World Index. Bloomberg only has data going back to 2005, but on this metric the sector on a relative basis has only been cheaper 8% of the time and all of that was during the pandemic.