Long-term investing: A tale of two banking sectors

As we note in another article ‘Long-term investing: Make time your friend’, not all markets are equal over extended periods. We used the example of the Japanese equity market over almost 40 years, which has lagged the US, and the world generally, over that period.

(Chart reproduced here for reference purposes only)

The case can be even stronger when comparing similar sectors across different geographies, like in the case of the European banking sector. A recent article by Reuters examined a hypothetical case of a 40-year-old French engineer considering his options at the end of 1998, just before the debut of the euro as the common currency for many countries in the region.

In the hope that the single currency will bring a new era of prosperity to the region, he resolves to invest a little in the European banking sector – a proxy for the region’s economy – every day for the next 20 years.

“And why not? Europe is expanding at its fastest rate in about 10 years, Germany has turned its economy around since reunification in 1990 and, with more than 10 Eastern and Central European countries queuing up to join the EU, there seems to be no shortage of growth on the horizon.”

“Moreover, a dot-com boom is fuelling belief in a promising IT-based ‘new economy’ ”.

“What could possibly go wrong?”

A lot, actually. Excluding dividends, the hypothetical French engineer lost money 98.5% of the time.

What makes the poor performance more remarkable is that over the same time, a similar strategy of investing in US banks would have made money 50% of the time. 

Chris Holdsworth, investment strategist at Investec Wealth & Investment, found a similar result when he examined the performance of German and US banks over a 31 year period (end- December 1987 to late January 2019).

“If you had bought the German banks index 31 years ago and diligently reinvested the dividends (and not paid any tax), then you would now be 35% down in nominal euros on the initial investment,” says Holdsworth.

By contrast, an investment in US banks of US$100 would be worth US$1,244 by late January this year (the same investment in German banks would be worth US$61), in reference to the chart below.

This outperformance by US banks is despite the fact that the subprime crisis, which preceded and was one of the root causes of the financial crisis of 2008, was very much US-centred and hit US banks hard. 

However, European banks were also in the firing line of the crisis, due to many of them being exposed to the debt instruments and other structures that imploded during this crisis. They were also exposed to the sovereign debt crisis of 2011 and to the sluggish growth that the region has experienced since then, as well as, an environment that consisted of extremely low-interest rates over much of that period.