October was a strong month for markets – European markets were up by 2.6% in euros whilst Europe ex-UK markets were up by 3% in sterling1 – in line with a strong US market and also benefitting from another well-received earnings results season.
I will make some observations:
The first chart below shows a breakdown by industry of European market performance year to date in dollars, which illustrates how much some of the key sectors have moved whilst the second chart shows the same thing since the end of 2020.
Both illustrate how extraordinarily well European banks have done as well as a high and the unusual level of sector divergence over both time periods but particularly this year. This matters in the context of a question we are being asked a lot at the moment: Are European banks ‘done’? Our answer: We think not…as we will discuss later.
Figure 1: Industry YTD returns inside Stoxx Europe 600 Index
Figure 2: Industry returns inside Stoxx Europe 600 Index – almost 5 years
Another observation I would make on the market comes from cutting performance differently and looking at it by factor – in particular, the Quality factor. The chart below shows the total return of the Morgan Stanley European High Quality and Morgan Stanley European Low Quality factor baskets vs. the market (MSCI Europe) YTD, showing another high level of divergence, this time between "low-quality’’ and "high-quality’’ stocks.
This caught a lot of market participants out this year given their very high exposure to high-quality stocks, many of which have savagely de-rated, accelerating a trend that started at the end of 2020.
In our European strategies, we have managed to largely avoid the ``meltdown’’ in high quality this year, although a couple of our stocks have been caught up in it – e.g. financial exchanges – unfairly in our view, but that is a matter of judgement.
What we have noticed – is that whilst we have a significant overweight in banks, we have missed out on some relative performance from our low ownership or non-ownership of low-quality stocks. We don’t pursue an investment process that targets stocks solely based on their high- quality status, and we have been disciplined in selling good companies when we believe valuations are excessive this year and over the past 5 years.
However, by following an investment process that excludes stocks that structurally earn Return on Capital Employed below their Cost of Capital, we are implicitly taking a structural bet against low quality, as low-quality companies tend to have sub-optimal returns through cycles. This works well most of the time but from time-to-time this costs us when we get ``trash’’ rallies.
There is certainly an element of judgement in all of this as stocks do migrate through factor baskets, and many of our bank stocks would have migrated through the low quality factors from 2021 onwards, and we deliberately owned them in the anticipation of rising Return on Equity based on macro variables we could see. But there are also stocks we may never own and from time-to-time we pay a small, short-term relative performance penalty for this.
Figure 3: Morgan Stanley Europe High Quality vs. Morgan Stanley Low Quality baskets vs MSCI Europe index
Back to banks – are they “done’’? I don’t think so for a number of reasons:
- The sector remains fundamentally cheap when we consider the Price to Book multiples vs. the achieved Return on Equity, suggesting the market is implying a decline in Return on Equity, which we do not think likely. Evaluating the sector on a Price to Earnings Relative basis shows a relative multiple vs. the market of 0.63x compared to a multi- decade multiple of 0.8x; a reversion to mean valuations on this metric suggests 25% upside to fair value on valuation factors alone.
- The sector experienced a number of key Return on Equity improvements such as significant consolidation, the movement of many banks into the private sector from savings/mutual sectors and a large amount of de-risking and deleveraging, which has improved the quality of balance sheets. We also believe that banks are likely to be a major beneficiary of AI and automation given the number of rules-based processes inside banks.
- The sector continues to see positive relative earnings revisions to the broader market and rising Return on Equity; these are usually strong signals of future performance.
Strategy risks
- Currency (FX) Risk - The strategy can be exposed to different currencies and movements in foreign exchange rates can cause the value of investments to fall as well as rise.
- Share Class Hedging Risk - The share class hedging process can cause the value of investments to fall due to market movements, rebalancing considerations and, in extreme circumstances, default by the counterparty providing the hedging contract.
- Pricing Risk - Price movements in financial assets mean the value of assets can fall as well as rise, with this risk typically amplified in more volatile market conditions.
- Market Concentration Risk (Geographical Region/Country) - Investing in a particular country or geographic region can cause the value of this investment to rise or fall more relative to investments whose focus is spread more globally in nature.
- Derivative risk - the strategy may use derivatives to reduce costs and/or the overall risk of the strategy (this is also known as Efficient Portfolio Management or "EPM"). Derivatives involve a level of risk, however, for EPM they should not increase the overall riskiness of the strategy.
- Liquidity Risk (general) - During difficult market conditions there may not be enough investors to buy and sell certain investments. This may have an impact on the value of the strategy.
- Counterparty Default Risk - The risk of losses due to the default of a counterparty on a derivatives contract or a custodian that is safeguarding the strategy’s assets.
Footnotes
1Source: Jupiter/Factset as at 30.10.2025. Past performance is no indication of future returns.
The value of active minds: independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
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