Managers warn on shorting Euro financials
European banks remain a “very, very dangerous sector to short” despite the opportunities presented by the escalating difficulties of Italian institutions, long/short managers have warned.
In what has proved another difficult year for the sector, banks in Italy have become the latest cause for investor angst, as fears mount about exposure to bad loans.
Managers fear the situation could further deteriorate, with some speculating problems in Italy’s banks could spread across the continent. Some indicators, such as Euro Stoxx Dividend Futures index, appear to have priced in an extreme recession.
James Inglis-Jones, co-manager of Liontrust’s European Strategic Equity fund, noted that the outcome of discussions about how to save Italian banks had become “more of a political risk”.
However, concerns about further pain in the sector have not been severe enough to persuade him to take short positions.
“It could escalate dramatically,” he said. “I’m not quite sure what the catalyst might be – we have got the forthcoming stress test on European banks. That could precipitate something quite serious.
“[But] I see that sector as a very, very dangerous sector to be shorting. Things have got to improve slightly and share prices are so beaten up they could double – or more – easily.
“[Financials] is an area brave people should be looking at [shorting]. You can sense there’s a lot of negative views being taken. Share prices have suffered horribly. They are trading on discounts to book value because people question what the book is.”
Share prices have already fallen significantly. Earlier this month Monte dei Paschi, Italy’s third-largest bank, saw its share price fall below 30 cents, having traded above €2 last summer.
Paul Casson, who works on the Artemis Pan-European Absolute Return portfolio, warned about the possibilities of a “short squeeze”, where a share price rise is amplified by investors subsequently closing short positions.
“Do you know what I think the main opportunity is? Doing something else. So many people are focusing on this area – why not focus on other parts of the market?” Mr Casson added.
He, instead, has been focusing on value opportunities in the energy sector, where expectations remain low because of recent oil price lows.
Others are more sanguine about the situation. Stephen Macklow-Smith, a strategist in JPMorgan Asset Management’s European equity group, argued that while Italy was “overbanked and requires more consolidation”, a full-blown crisis appeared unlikely.
“We are in the middle of a solution to an Italian banking problem, not at the beginning of a crisis,” he said.
“If there is a solution there could be a huge opportunity in Italian banks, as stocks are trading at a steep discount to book.”
Mr Inglis-Jones said he came across few financial opportunities as part of the process deployed by his fund, but suggested some value plays could be found.
“There’s a big difference in the valuations of stable institutions [and less-stable ones] in Italian banks. When that happens, it tends to be a sign of longer term valuation opportunities. That takes away the opportunities on the short side,” he said.
KEY NUMBERS
€360bn: Estimated amount in non-performing loans within the Italian banking system
€0.27: Share price of Monte dei Paschi in late June, down from more than €2 in summer 2015