Bank stocks have further to run

Could exceptional earnings for large US banks mark a peak for the sector? We explore the drivers of recent strength, the implications for European lenders, and our broader positive outlook.

Large US banks had a very strong second quarter. The surprise boost came from equity trading revenues, amid high market volatility linked to the Middle East conflict and swings in AI sentiment. A resurgence in deal-making, equity and bond issuance helped investment banking fees, leading to returns on tangible equity of over 20% for the largest firms. At the same time, credit conditions remained benign and loan growth improved. All six of the largest US banks beat analysts’ earnings and revenues estimates. Earnings rose on aggregate by 40% and revenues by 20% year-on-year. Most banks gave a largely constructive outlook for the remainder of the year.

All six of the largest US banks beat analysts’ earnings and revenues estimates

The large US banks have enjoyed several quarters of high trading revenues, but this one was exceptional. This was partly due to one-off items: high-profile IPOs, exceptional profitability from services to hedge funds in Asia, and some index rebalancing that led passive funds and benchmarked investors to trade stocks in large quantities. It would thus be unwise to extrapolate; a repeat of the exceptional second quarter seems unlikely, even if volumes remain high amid ongoing uncertainty around geopolitics and AI winners and losers. Crucially, in a highly concentrated market, only a few of the largest US banks stand to benefit from bumper trading fees.

Bank stocks have also had a strong year already. The KBW Bank index, which tracks 24 large US banks, is up by around 15% year-to-date, and the MSCI World Banks index by around 16%. Although there is huge variation, on average, US banks now trade at around 1.75 times book value, levels not seen since before the Global Financial Crisis. Investors are questioning whether the second quarter will mark a peak in valuations and earnings, if capital market activity can continue at these levels, and whether strong results for the biggest US firms will be mirrored at smaller, regional lenders and in Europe in the weeks ahead.

We retain a constructive outlook on US and European banks. The financials sector – of which banks represent just under half by market capitalisation globally – has benefited recently from a broadening of equity market performance beyond tech, and a rotation towards cyclical companies. This has been particularly marked since early June, and is a trend that we expect to continue. Strong second quarter earnings make full year 2026 expectations for US banks appear less demanding and earnings revisions remain positive. The broader financial sector is expected to generate robust earnings growth this year, supported primarily by banks and US capital markets firms.

The financials sector has benefited recently from a broadening of equity market performance beyond tech, and a rotation towards cyclical companies

We see several drivers behind the earnings momentum for banks. Firstly, we expect robust global growth and resilient macroeconomic fundamentals to remain in place. In the US, markets are now pricing in higher policy rates from the Federal Reserve for longer, which supports net interest income, or the difference between revenues made on loans versus the interest paid out on deposits. Financial conditions remain benign with little sign of consumer or corporate credit stress to date – indeed discussions of asset quality were notably absent from earnings calls.

Secondly, we see loan growth continuing, amid solid demand for commercial lending, in part linked to AI, and a nascent improvement in merger and acquisition activity. This growth must be funded, leading to some competition on the deposit side, but overall at the biggest six US banks, net interest income came in broadly in line with or slightly above analyst estimates. Banks are also using healthy capital buffers to fund this growth, and to sustain dividends. A Federal Reserve stress test, released in June, showed participating US banks held almost 10% of their market capitalisation in excess capital. Indeed, buybacks and dividends for US financial firms have risen by around 50% year-on-year thanks to regulatory and earnings tailwinds, with total shareholder yields of around 5% and scope for this figure to increase.

We see loan growth continuing, amid solid demand for commercial lending, in part linked to AI

We also note that a recovery in capital market activity could last longer than a single quarter. The AI infrastructure buildout offers a multi-year tailwind for investment banks, while the global boom in capital spending could drive further corporate borrowing in energy, infrastructure and defence. Improving conditions may drive more activity by large private equity funds with a backlog of companies to sell, although capital market activity tends to fluctuate from one quarter to the next.

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A different landscape in Europe

In Europe, the market and regulatory landscape looks very different, and we do not expect second quarter results to be as impressive. While some banks will benefit from Asian equity trading, European bank earnings are in general less exposed to capital market activity, and within this, more exposed to bond rather than equity trading, where activity has been good but not exceptional.

Yet like the US lenders, European banks are also seeing loan growth in some regions and segments. The macroeconomic backdrop looks stable, albeit unspectacular. Interest rates have risen once in the euro area this year, and could do again in September, and banks have taken the opportunity to reinvest maturing fixed-rate investments at higher rates. These trends are all supporting net interest income.

Capital returns look attractive, with an average 5% dividend yield, plus the potential for further share buybacks. In general, we think that improving returns on equity are not yet reflected in valuations for European banks, which still trade at close to a 30% discount to US peers.

We think that improving returns on equity are not yet reflected in valuations for European banks

AI exposure is a double-edged sword

We also see scope for the banking sector to benefit from AI-driven cost efficiencies, given the potential to overhaul legacy IT systems and manual processes – although some will face pressure to pass these on to customers. But banks’ increasing exposure to AI also represents a risk. It was a huge earnings driver for the biggest US banks in the second quarter, largely from helping to fund firms’ AI-related capital spending, but also from AI-linked equities trading and wealth creation. A reversal in AI sentiment thus represents a real risk, but given its importance to wider equity markets, not one confined to the financial sector.

There are also growing concerns that AI could increase competition for bank deposits, if agents that are capable of scanning the investment landscape and automatically switching money to the highest yielding accounts become widespread. For some lenders, this has been weighing on valuations. 

Another prominent risk for the sector would be if a worsening of the US-Iran conflict and disruption in the Strait of Hormuz revives fears of slower growth and rising inflation. However, this is not our core scenario, and overall, we see positive conditions prevailing for banks. A stable macroeconomic backdrop and capital market recovery should sustain high single-digit earnings growth. At the same time, market trends remain favourable, including a broadening of returns beyond technology firms, and an ongoing rotation into cyclical stocks that should continue to benefit the broader financials sector.