UBS Equities-Global Equity Strategy _Still Banking on Banks_ Garthwaite-116739489

ab23 July 2025Global ResearchGlobal Equity StrategyStill Banking on Banks We have long been overweight banks and continue to be so strategically. Our colleague Gerry Fowler is also overweight banks on his REVS framework (see here). We see the following supports but as always note that one needs to pick the right regions and stocks.Macro: i) a hedge on rising populism. One of our largest top-down concerns is that populism results in ever-growing fiscal imprudence (last year was the first time in 120 years that in each of the major DM the incumbent either lost power or their majority). We calculate that already fiscal tightening of c3% of GDP is required to stabilise government debt to GDP in the US. Banks win relative to other sectors from rising bond yields (they are the second best-performing sector when TIPS yields rise) - banks' performance is closely correlated to a steepening yield curve; ii) strong currencies in Europe/UK and Japan (banks are one of best-performing sectors when the Euro or Yen appreciate) and EM banks outperform when the dollar weakens - we remain dollar bears (see here); iii) rising private sector loan growth - private sector leverage is abnormally low and clearly turning in Europe (especially corporate lending in France and Italy). We have a macro model that shows European banks are just in line with fair value using PMI, Bund and the Euro, yet PMIs and the Euro are projected to rise by UBS; UK and Japanese banks look cheap on the same variables.Valuation discounting a significant slowdown: In Europe and the US, banks are trading on a c10% P/E discount to their norm. In Europe's case, we think the cost of equity at 11.6% is too high relative to the US (8.8%) or the permanent write-down coco (6%) and should, at worst, be 10%. To get the c10-14% EPS downgrade being discounted, charge-offs would have to rise 20bp or rates fall sub 1% - both would require a sharp slowdown in growth which seems unlikely. Since "Liberation Day", UBS has left global GDP in 2025 and 2026 unchanged at 2.9% and 2.8%. Think of Australia if you worry about valuation: the ROTE is below Europe (on 2025 estimates), but they trade on 3X book (2X ex CBA). Reasons Banks should be re-rated: i) Banks appear far more immune to a recession this time. This is because they have not done higher-risk lending for very many reasons (such as stress tests, high capital charges for risky lending, and regulation). Sweden has shown into recession that NPLs didn't rise meaningfully and banks outperformed in the recessionary period (Q3 22-Q1 24 when GDP fell 2.4% and house prices fell 12.5%); ii) the non-macro headwinds have very sharply diminished: in general, deleveraging is done (indeed, B3 is being eased); iii) litigation and fines appear less as bankers are not being criticized for the economic backdrop - unlike post GFC - and their risk controls are much improved; iv) less disruption risk than generally perceived for example three years ago, as disrupters face