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European Banking Sector: Phoenix or Frankenstein?

Don't break out the bubbly quite yet

by Nico Isaac
Updated: February 02, 2017

After a decade of doom and gloom, bankruptcies, bailouts and failures, many of Europe's financial leaders are ready to call it the official end of the Eurozone banking crisis. Here, these news items set the bullish tone:

"European Banking Sector: Key Reasons to Invest in 2017" (Jan. 26 The Corner Economic)

"European Banks Get Profit Upgrades After Undershooting Six Years." (Jan. 30 Bloomberg)

"Like a phoenix from the ashes, European banks have transformed from being one of the most unloved sectors of 2016 to an investor favorite in the new year". (Jan. 27 MarketWatch)

What has them so convinced?

One very specific number: 20. As in, the percentage gain in Europe's banking bellwether exchange traded fund -- the Euro STOXX 600 Bank index -- since November 2016.

But before you break out the dusty bottle of bubbly to celebrate a banking comeback, we have a few other numbers you may want to consider.

  • 2007: The year of the global financial meltdown began, when the seemingly infallible facade of the world's biggest banks shattered into a trillion pieces.
  • 2007 was also the year that saw the biggest banking M&A bonanza ever, culminating in "largest merger in global financial history" (April 23 CBS News): the April 2007 Barclays PLC acquisition of ABN Amro for $91.6 billion.
  • The same year that Federal Reserve Chairman Ben Bernanke said "we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system" in a May 18 speech.
  • The same year Bank of America was named the "Best Stock for 2007" -- two months after BOA stock peaked and embarked on a 90% crash to its March 2009 low.

In other words, we have our own reasons to second guess -- or at the very least, double check -- when the usual powers that be say things like "the worst is over." In fact, in 2007, amidst the widespread optimism surrounding Europe's banking sector, our European Short Term Update steered its subscribers' attention toward the DJ Euro Stoxx Banks Index.

At the time, as the index stood near its highest level in history, our November 2, 2007 European Short Term Update warned the banking sector was now Europe's weakest link and suggested the index had now entered a downtrend:

"The XData window on my chart is a ratio of the banks Sector divided by the overall Euro Stoxx Index. As you can see, banks have under-performed the general market significantly and the trend remains down. The 30-week Percent R study is falling and is near the bottom of its range. This is consistent with a bear market for the sector. The reason I include the 10-week Rate of Change study is to rank the various sectors on their performance relative to each other. The Bank Sector has the lowest 10-week ROC, so I view it as THE weakest.

Next, our November 12, 2007, European Short Term Update added this chart of the bank index, which showed a completed uptrend from its 2003 low via a clear five-wave Elliott wave advance.

"The monthly chart of the [DJ Euro Stoxx banks] sector displays five waves up from October 2002 through May 2007. The decline has already fallen through the March 2007 low of wave (4) and is likely to continue down to the June 2006 low of wave 4 of (3)."

We all know how the story went from there: The worst global financial meltdown in recent history followed, tearing down banking behemoths as big as Northern Rock, which in September 2007, galvanized Britain's first bank run since 1866. (chart of the DJ Euro Stoxx Banks Index from stoxx.com)

That was then.

The question now -- is Europe's banking sector really a phoenix rising out of the ashes -- or, a dead man walking?

Writes our January 2017 European Financial Forecast:

"...the Bloomberg Europe 500 Financial Industry Index barely recovered half of its losses from 2007...

With banking shares about to move [in one particular direction], investors will come face to face with one of the harshest truths in modern finance."

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