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Europe Financial ETF Just Can’t Catch a Break

This article was originally published on ETFTrends.com.

European banks and financial sector-related ETFs have been underperforming as a slew of negative factors keeps pressure on the beleaguered market segment.

Year-to-date, the iShares MSCI Europe Financials ETF (EUFN) , which provides a targeted play on European financial companies, rose 7.5%. Meanwhile, the broader Vanguard FTSE Europe ETF (VGK) and iShares MSCI EMU ETF (EZU) , which both contain heavy stakes toward the financial segment, were 10.3% and 9.4% higher so far this year, respectively.

Weighing on Europe's financial sector, the plunging yields have dragged rates on some government bonds back into negative territory, there is rising concerns over a slowing economy and a money laundering scandal has driven compliance costs higher, the Wall Street Journal reports.

Consequently, the Euro Stoxx banks index has fallen behind the broader market, advancing less than 5% this year, compared to the nearly 11% gain for the broader Eurostoxx 600 benchmark index. Furthermore, European banks now trade for 70% of their book value, down from above 100% in early 2018 and far below that of their U.S. peers.

“The sector is a value trap now,” Fabio di Giansante, head of large-cap European equity at Amundi, told the WSJ. Even though valuations are at “almost unprecedented levels” compared with the broader European markets, economic troubles and low rates will keep pressure on bank shares.

“The stock market is pricing either a big recession coming up or the fact that maybe the marks on some of the assets in some of those European banks are incorrect,” Filippo Alloatti, a senior credit analyst at Hermes Investment Management, told the WSJ, adding that while the banks will have trouble growing profits, they remain well capitalized.

The most recent round of safe-haven investing, which pushed rates down, with some Europe government bond yields back in the negative, are constraining European banks' profits by tightening net interest margins, or the difference between what banks pay for funding and make from loans. Moody's analysts calculate that German banks see net interest income account for almost 70% of revenue and most interest-earning assets are long-term, so any future benefits of rate rises would come with a lag.

“Equities are rising partly because the cost of credit is not going to increase as quickly as people expected and that’s good for everyone except for banks,” Jason Napier, head of European banks research at UBS, told the WSJ.

For more information on the European markets, visit our Europe category.