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¹ The World Bank, 2021, Publication: The Economic Case for Nature: A Global Earth-Economy Model to Assess Development Policy Pathways, p47.

Recent market developments and investing trends have prompted investors to reconsider their investment allocations. Factors assist investors in understanding the present market and informing their investment decisions.

Melissa Brown, Managing Director of Applied Research, joins two experts to discuss factor investing in this video.

The STOXX benchmarks also include the STOXX North America 600 Index, STOXX Asia/Pacific 600 Index, STOXX Global 1800 Index, STOXX Europe Total Market Index, STOXX EU Enlarged Total Market, STOXX Eastern Europe Total Market and STOXX Eastern Europe 300 Index. They are also part of this regular quarterly review.

All additions and deletions can be found here: https://www.stoxx.com/index-updates.

The collapse of Silicon Valley Bank (SVB) and the forced takeover of Credit Suisse by UBS has raised fears of systemic risk contagion in the banking sector, triggering widespread selling of lenders’ equities and debt around the world. It has been European banks’ shares that have led losses, and the region’s banking sector risk has climbed above that of the global one.

This article will analyze the losses registered by financial stocks around the world between March 10, the day when SVB failed, and March 24. The STOXX^® Europe 600 Financials index dropped 9.3% over the period, nearly three percentage points more than the STOXX^® Global 1800 Financials index. The former’s decline has wiped out all its gains in 2023 (Figure 1).

European Banks, Financial Services, and Insurance — the three Supersectors within the broader Financials Industry as defined by the ICB classification — each fell more than their global counterparts in the ten business days under consideration. Yet, the Supersectors in Europe still show higher 2023 returns than in the global landscape following strong performances in January and February.

Among the three Supersectors, European Banks were the hardest hit in the recent turmoil, falling more than 12%, followed by Insurance (-7%) and Financial Services (-5%). Insurance has recorded a 3% year-to-date decline as of March 24, while European Banks and Financial Services are still in positive territory.

Global Financials and each of its Supersectors are down for the year, with the STOXX^® Global 1800 Banks index underperforming the global market by 11 percentage points.

Figure 1: Cumulative returns in EUR

The rest of the study looks at the reaction of banks, financial services and insurance companies by country and region over the recent turmoil.

Returns by country

US banks fell 12% in the wake of the industry collapse (Figure 2). Banks in six European countries saw even larger stock declines, led by Germany (21%) and Austria (20%). Only banks in Singapore managed to post gains.

Figure 2: STOXX^® Global 1800 Banks index: returns by country

Financial Services companies in Switzerland (which include Credit Suisse and its rescuer, UBS), fell the most (12%) (Figure 3). The US saw one of the smallest losses in this category, of about 2%.

In contrast, Hong Kong, Germany and Singapore posted small gains. This is because Financial Services includes stock exchanges, which benefit from higher trading volumes amid extensive selling.

Figure 3: STOXX^® Global 1800 Financial Services index: returns by country

While most eyes were set on Banks, Insurance companies were not left unscathed. This is because systemic risk has increased in the insurance sector, partly as a consequence of its growing ties with banks.

Insurers’ stocks were down in all countries in the STOXX^® Global 1800 index (Figure 4). Once again, European countries bore the brunt of selling, with the Netherlands posting losses of 15%. In comparison, US insurers were down only 4%.

Figure 4: STOXX^® Global 1800 Insurance index: returns by country

Country contributions to index loss

US and European banks were mostly responsible for the 10% decline in the STOXX^® Global 1800 Banks index (Figure 5).

UK, Spanish, French and Italian banks were the main culprits for the 12% fall in the STOXX^® Europe 600 Banks index. Surprisingly, Swiss banks have a minuscule weight in the index (0.6%); instead, large Swiss financial institutions are categorized under Financial Services, and we will see their impact on that Supersector.

All but one of the 42 stocks in the STOXX^® Europe 600 Banks index fell after March 10, with some losing over 20% of their equity.

Figure 5: Contribution to Global and European Bank index returns by country (March 10 to March 24, 2023)

Switzerland was largely responsible for the drop in the European Financial Services Supersector (Figure 6). Except for Credit Suisse, which plunged 70%, there were lower magnitude losses among European Financial Services firms than the ones seen for European banks.

Credit Suisse held a relatively small weight in the STOXX^® European 600 Financial Services index but was still the largest contributor to the index’s loss. UBS, which represents nearly 18% of the index, was the second-largest negative contributor.

Two of the largest stocks in the index — Deutsche Börse and London Stock Exchange (each weighing 10% in the index) — offset some of the overall losses.

Figure 6: Contribution to Global and European Financial Services index returns by country (March 10 to March 24, 2023)

The downfall of insurers in Europe contributed more than 40% to the 5% decline in the STOXX^® Global 1800 Insurance index (Figure 7). The US (34%) and Japan (15%) were the other large detractors.

The STOXX^® Europe 600 Insurance index fell 7% over the short period, with all but one of its 31 constituents dropping.

Figure 7: Contribution to Global and European Insurance index returns by country (March 10 to March 24, 2023)

Risk forecasts

The risk of European banks jumped 44% following SVB’s downfall, much more than it did for Global Banks (Figure 8). By March 24, the risk forecast for the STOXX^® Europe 600 Banks index had exceeded that of the STOXX^® Global 1800 Banks index, as measured by Axioma fundamental short-horizon models, reverting the situation earlier in the year.

The risk of European Banks, Financial Services and Insurance is now higher than it was at the beginning of the year, while, so far, that is not the case for their global counterparts.

Figure 8 – Risk on Financials Supersectors: Banks, Financial Services, Insurance

Conclusion

Despite regulators’ efforts to limit the damage from the bank upheaval, investors are becoming more and more anxious about a contagion effect among financial institutions and a cascading impact on other industries. For an analysis on the potential effects on stocks of a widening banking crisis, see the blog post ‘Bank Credit spread contagion – how bad can it get?’

So far, the effect on other sectors has been fairly contained, but a further deterioration of bank credit quality could drag other industries into negative territory as well. Our stress tests indicate that bank shares could fall another 15% in the US and almost 20% in Europe, if credit spreads were to widen another 200 basis points from their already elevated levels. But traditional defensive sectors, such as utilities, consumer staples or healthcare, could provide some protection, with losses projected to remain in the low single digits.

For most of the past two decades, spreads on bank debt have vacillated largely in line with overall credit risk premia. The dark blue line in Figure 1 shows the 5-year yield pickup of USD-denominated, single-A-rated bank bonds over risk-free rates since 2007, while the green line represents the average spread of all corporate securities with the same currency and credit quality. 

Figure 1 – Average 5-year spreads over USD risk-free rates for global corporates and banks

_{Source: Axioma Fixed Income Spread Curves.}

As seen from the light blue area, the two major exceptions when the two time series diverged were during the global financial crisis in early 2009 and the Eurozone debt crisis of 2011/12, when borrowing rates for financial institutions increased much more than for overall corporate debt. Especially in the second half of 2011, the yield differential expanded to 170 basis points, with the single-A bank spread peaking at almost 4%. At the moment, the latter has just spiked above 2%, with a pickup of more than 60 basis points over all corporates — its widest since the end of 2012.

The similarity between the recent problems of the troubled US banks (the issues with Credit Suisse appeared to be of a more deep-rooted, structural nature and have been going on for much longer) and the Eurozone debt crisis is that in both cases, the affected institutions had large holdings of long-dated government debt that were marked down significantly as interest rates soared.

Equity market impact

The charts in Figure 2 show simulated returns for representative US (left) and European (right) equity sector portfolios under a range of historical and transitive scenarios. The light blue bars indicate how today’s portfolios would have fared under market conditions prevalent in the second half of 2011, while the green bars represent their hypothetical returns based on market movements since March 8, 2023. The dark blue bars are projected future returns if credit spreads for USD-denominated, single-A-rated banks were to widen another 200 basis points. The betas and covariances for the latter stress test were calibrated using daily returns since March 8.

Figure 2 – Simulated returns for US (left) and European (right) equity sectors^[1]

_{Source: Axioma Risk. Data as of March 22, 2023.}

The green bars in both charts indicate that the most severe share-price losses have so far been concentrated in the financial and commodity sectors, while technology, healthcare and utility stocks have to date escaped largely unscathed. Between March 8 and 22, 2023, global bank shares lost 11% on average, compared with -1.4% for the STOXX^® Global 1800. However, if spreads on bank debt were to widen another 200 basis points from their current levels, the dark blue bars predict losses across all sectors, with US bank stocks projected to shed another 15%. The pullback could be even larger for their European counterparts, which could lose as much as 19% of their market capitalization.

That being said, the downturn can be expected to be much more benign in traditionally defensive industries, with losses being confined to single digits for utility, consumer staples and healthcare companies. The historic returns from the Eurozone debt crisis, represented by the light blue bars, appear to confirm this notion.

Debt market impact

The picture looks slightly different in the debt market, where credit spreads widened across all sectors, though the underperformance was much more severe for financial securities. Figure 3 depicts excess returns of USD-denominated corporate bonds over US Treasury securities. In order to make returns comparable across sectors and time periods, the performance numbers were normalized to an average duration of six years.

Figure 3 – Simulated excess returns for USD-denominated corporate bonds

_{Source: Axioma Risk. Data as of March 22, 2023.}

Even though the recent excess returns (represented by the green bars) were negative, the simultaneous flight to quality meant that the plummeting sovereign yields largely compensated for the wider credit spreads, resulting in flat or even slightly positive total returns for most non-financial securities. The inverse relationship is likely to persist if things take a further turn for the worse, thus cushioning at least some of the projected losses shown by the blue bars.

Should investors be worried?

The stress tests indicate a certain degree of contagion with all parts of the economy eventually experiencing losses, if credit conditions were to deteriorate to the levels observed during the Eurozone debt crisis. European bank shares especially could suffer additional losses of up to 20%. However, not all sectors will be hit equally hard, and more traditional defensive industries like utilities, consumer staples and healthcare might offer some refuge. Corporate bonds are also likely to get some relief from lower risk-free rates, which would dampen the blow of higher credit risk premia.

^[1] The sectors displayed are GICS sectors (level 1), apart from Banks, which represent the industry group (level 2) within the broader Financials sector.