The financial turmoil of recent months has dragged global bank stocks close to their lowest valuation in four decades.
That suggests there are buying opportunities in the sector, observers say. The risks from Europe's debt crisis and a sluggish U.S. economy provide good reasons for financial companies in those regions to be selling so cheaply, but banks in other regions may be undervalued.
"While we agree that European and American banks are not out of the woods yet, we argue that the financial sector is oversold in countries with sound banking systems," Pierre Lapointe and Alex Bellefleur of Montreal-based Brockhouse Cooper said in a strategy note. "We believe that the financials decline in countries with sound banking systems is overdone."
They recommend overweighting financial shares in Canada, South Africa, Norway and New Zealand, according to the report, published last Friday. Canada has ranked No. 1 worldwide for the past four years in a survey by the World Economic Forum that asks business leaders in each country to rate the soundness of their banks.
Brockhouse Cooper analyzed the price of financial shares in the S&P Global 1200 index in relation to the long-term trend in earnings and found it to be near its cheapest since the early 1970s. The earnings yield - or earnings per share divided by price - of the financials is the highest of the index's 10 industry groups and 2.3 percentage points higher than the yield on a Barclays index of below-investment-grade bonds.
"In other words, investors prefer junk bonds to financials," Mr. Lapointe and Mr. Bellefleur said in their note.
Financials have also led declines in the broad S&P Global 1200 index since it peaked in October, 2007, and now have the lowest price-earnings ratio among the index's 10 industries.
"The banking sector, by historical standards, is trading extremely cheap," said Peter O'Reilly, who oversees $6-billion (U.S.) in assets as head of global equities for Investors Group in Dublin.
Mr. O'Reilly co-manages the Investors Group Global Financial Services Fund, whose top holdings include U.S-based Wells Fargo & Co., JPMorgan Chase & Co. and Prudential Financial Inc., DnB NOR ASA of Norway and BNP Paribas SA of France.
He said investors should be aware of the risks from Europe's debt crisis and a global economic slowdown. In addition, regulators are pushing to impose stricter capital rules on banks, which could lead to reduced lending and smaller profits. While Canada is among the "poster boys" of countries with safer banking systems, excessive debt levels and house prices in this country could also pose a risk to lenders.
"If you are confident that the global economy is going to come back, and you are confident that regulation is not going to destroy the business … there's plenty of opportunities in the global financial services sector for those willing to swallow a bit of volatility," Mr. O'Reilly said.