Bank Street test was out. Industry upgraded

Source: DB

The announcement from the Basel Committee on Banking Supervision is the news
we’ve all been waiting for (www.bis.org/press/p100726/annex.pdf). Worries over
leverage ratios, funding and liquidity requirements are now much reduced (see
Matt Spick’s Banks Alert, 27 July). We have been underweight Banks since
December 2009 and we are now moving the sector to neutral. We are funding this
upgrade from Food & Beverage which we are cutting to neutral, a sector where
we have been overweight also since December 2009. Year-to-date, Banks have
underperformed the DJ Stoxx 600 by 4.2% and Food & Beverages have
outperformed by 11.2%.
With the stress tests at least now out of the way and the Basel Committee
coming through with a less stringent set of recommendations, we think the bank
sector now looks ripe for a sustainable recovery, sitting on a price-to-tangible book
of only 1.2x 2010E and 1.1x 2011E.

There is nothing particularly wrong with Food & Beverages (earnings revisions
remain strong), but alongside Healthcare it continues to be the most negatively
correlated sector with Banks, and the valuation of Food & Beverages is a lot more demanding than Healthcare. The sector’s PE relative (1.4 on forward earnings) is at a 12-month high and an 18% premium to its 10-year median. This compares with a PE relative of 0.9 for Healthcare, and a 25% discount to its 10-year median.
Earlier this month, we implemented a tactical move to slim down our cyclical
exposure as PMIs were starting to peak and US economic data was falling short of
expectations. Our upgrade to Banks and downgrade to Food & Beverages does
not, in our view, detract from this position – we remain overweight Telecom,
Healthcare and Personal care and underweight Construction and Autos. But with
regulatory risk in the financial sector (and Basel 3 in particular) having been a major drag on market sentiment, this news could help to engender a better performance
from the market overall.