At least in most places. Japanese banks have had a tough time, as the Bank of Japan for many years kept rates below zero. Banks in Japan have effectively been altitude training, eking out a return from the thinnest of margins. This March saw Japan finally raise interest rates above zero, and the banks have outperformed on renewed optimism for higher earnings and higher returns to shareholders as corporate governance in Japan continues to improve. While we believe they still offer reasonable value, we have reduced our positions in the Japanese banks as their valuations have risen above 10 times earnings.
Our Korean banks have also performed well, with improving prospects that they will finally pay out a higher proportion of their earnings to shareholders. To say that Korean banks are overlooked would be an understatement in our view. Currently trading at around half their book value, the banks are priced as if they are in the teeth of a perilous crisis. But when we look for the red flags that might signal distress, we see nothing of the sort. Banks in a crisis have shaky balance sheets, but our Korean banks are solid. Banks in a crisis may hold assets at inflated prices that need to be marked down, but that’s not so at the Korean banks. Banks coming into a crisis are often overearning, but our Korean banks aren’t sacrificing resilience to chase returns.
In Europe, our bank holdings appear to be suffering from a similar strain of apathy. Markets seem to believe we’ll soon return to the bad old days of intense regulatory pressure, near-zero interest rates, and curtailed payouts. We disagree. With reasonable interest rates, we believe our European banks can earn returns on equity well above 10% over the long term. And with little need to rebuild capital, they can pay ample dividends—Bank of Ireland, AIB, and ING offer dividend yields above 5%.
Our banks have improved, as have the conditions for them to make money. Yet we don’t believe that is reflected in their share prices—our core Korean and European banks all trade for less than 8 times earnings.
In our view, the banks are good illustrations of how contrarian investing works in practice. In a year that has seen a banking crisis on one side and a wave of artificial intelligence enthusiasm on the other, this handful of humble banks has managed to outperform. That is often how it goes—fear comes in loudly but goes out quietly, and the road from all-out fear to a shrug of the shoulders can be a very rewarding one for long-term investors.
