Recently, the Shanghai Composite Index has continued to show weakness, while the banking sector has repeatedly set new highs.

As of the close on August 20th, the Shanghai Composite Index fell by 0.93% to 2,866.66 points, the Shenzhen Component Index closed down by 1.24%, and the ChiNext Index declined by 1.34%. In contrast, the banking sector has shown strength against the trend, with the China Securities Banking Index (399986.SZ) closing up by 0.3%, marking four consecutive trading days of gains. In August, when the Shanghai Composite Index has accumulated a 2.45% decline, this index has achieved a 3.69% increase.

Bank stocks have been "frenzied" purchases by capital within the year, with the share prices of the five state-owned major banks, including China Construction Bank, Agricultural Bank of China, Industrial and Commercial Bank of China, Bank of China, and Bank of Communications, successively reaching new highs. On that day, Agricultural Bank of China set a record high price of 4.94 yuan during the trading session, China Construction Bank's closing price was reported at 8.18 yuan, Industrial and Commercial Bank of China's share price climbed to a peak of 6.4 yuan during the trading session, Bank of China also set a record high of 4.97 yuan, and Bank of Communications rose to a peak of 7.98 yuan.

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Industry insiders analyze that bank stocks have low valuations but high dividends, which have configuration value. The increase in holdings by various funds, especially the influx of ETF funds, has become the basic logic for the surge in bank stocks. Coupled with the recent disclosure of the "mid-term exam" results by several listed banks, the net interest margin has shown a slight trend of stabilization, which has driven the continuous rise of bank stocks.

Bank stocks are striding up amidst a general decline in individual stocks in the A-share market. Since the beginning of this year, the China Securities Banking Index has achieved a 19.92% increase, with the cumulative extent almost catching up with the 22.65% for the whole year of 2021.

Several individual stocks have also set their largest gains in the past five years. As of the close on August 20th, six bank stocks have accumulated a gain of more than 40%, which are Nanjing Bank, Bank of Communications, Agricultural Bank of China, Chengdu Bank, Industrial and Commercial Bank of China, and Hangzhou Bank. Only three bank stocks have declined, which are Zhengzhou Bank, Lanzhou Bank, and Minsheng Bank.

Amid the rising risk-aversion sentiment among institutions this year, the banking sector, with its high dividend and low valuation characteristics, has become a preferred choice for capital. Coupled with the increased defensive sentiment in the market since last year, it has further catalyzed the performance of the banking sector. A public fund manager told the reporter, "Under the 'asset scarcity,' the dividend logic of the banking sector has configuration value, and it can be regarded as a fixed-income asset. At the same time, its relatively low market valuation means that there is still room for the banking sector to rise."

With the recent disclosure of the semi-annual reports of listed banks, the dividend plans of Ping An Bank and Shanghai Rural Commercial Bank have also become the focus of investor attention, and 15 other banks have previously confirmed that they will prepare to implement interim dividends. Looking back at the dividend plans of listed banks in 2023, Wind data shows that a total of 41 listed banks have a combined dividend of 613.3 billion yuan, of which the six major banks have a cumulative dividend of 413.3 billion yuan, accounting for nearly 70%.

"The systematic downward trend of the market's risk-free interest rate is significantly lower than the dividend rate of bank stocks," said Liang Fengjie, the chief analyst of the banking industry at Zheshang Securities. Due to the real estate cycle entering the second half, various financial products have broken the rigid payment, and since 2023, the risk-free interest rate available to residents has been systematically lower than the dividend rate of bank stocks. "It is better to buy banks than to deposit in banks" has become a reality.As of the latest closing day, among the 42 listed bank stocks, 39 have a dividend yield exceeding 3%, with Ping An Bank leading at 9.33%. The average dividend yield of the five major state-owned banks has reached 4.77%, with China Construction Bank at 4.89%.

In addition to the high dividends brought about by generous dividends, the low valuation of bank stocks is also an important logic for capital allocation. The high profits and low valuations of listed banks have been a common topic, with factors related to profits, such as net interest margin, changes in income, and the scale and structure of assets and liabilities, all potentially acting as "drivers" for low valuations. However, regardless of the changes, in terms of the price-to-book ratio, the valuation of listed banks is clearly at a low level. Even with a "surge" in bank stocks within the year, as of the latest trading day's close, the price-to-book ratios of all 42 listed bank stocks are below 1 times, with Minsheng Bank being the lowest at 0.28 times.

"No matter how high the increase, looking at the unit price of bank stocks, many are actually in the single digits," the aforementioned fund manager told the reporter, stating that bank stocks are at a low price in the entire A-share market and still have room for appreciation.

What factors are driving this?

From a comprehensive market perspective, the capital side is considered the main driving force behind the rise in bank stocks. The capital mainly comes from passive funds, insurance funds, and bank wealth management. The recent surge in bank stocks is mainly due to the increase in positions by passive funds. Dai Zhifeng, the chief analyst of the banking industry at Zhongtai Securities, believes that passive funds are an important force in driving the rise in bank stocks.

During the year, passive funds have significantly increased their positions in the CSI 300 Index. As of the latest closing day, the net asset value of the CSI 300 ETF has increased from 131.1 billion yuan at the beginning of the year to 269.8 billion yuan, more than doubling; the net asset value increase of the CSI 300 ETF Yifangda and the CSI 300 ETF Huaxia is close to three times. With a large influx of funds, bank stocks, as the largest weighted sector in the CSI 300 Index, have significantly benefited.

According to estimates by the Xingye Strategy Team, as of last Friday (August 16), the net inflow of stock-type ETFs within the year is about 629.3 billion yuan, of which broad-based ETFs have a net inflow of 635.9 billion yuan. Broad-based ETFs are the core incremental source, and among them, the most inflow is for ETF products tracking the CSI 300 Index, with a net inflow of about 447.7 billion yuan within the year, accounting for more than 70% of the total broad-based inflow.

Another major source of funds is insurance. "The dominant incremental funds this year are mainly two parts, one is ETFs, and the other is insurance. Both of these funds have a high proportion of allocation to banks, thus becoming an important driver for the rise in bank stocks," said a securities analyst in the banking industry.

According to data from the National Financial Regulatory Administration, as of the first half of this year, the total premium income of insurance companies has increased by 10.65% year-on-year, and the balance of insurance funds used has increased by 9.62% compared to the beginning of the year. The combined scale of stocks and funds held by property insurance and life insurance has increased by 136.9 billion and 169.3 billion yuan respectively. Among the heavy positions of insurance funds, the proportion of bank positions is as high as 48.3%, an increase of 0.8 percentage points from the beginning of the year.

However, the reporter noticed that some insurance funds are preparing to sell the high-rising bank stocks. On August 20, Hangzhou Bank issued an after-market announcement stating that China Life, a shareholder holding 1.86% of the shares, plans to reduce its holdings by a total of no more than 110,092,230 shares, i.e., no more than 1.86% of the company's total ordinary shares, through centralized bidding or block trading within three trading days after the announcement is disclosed, within a period of three months.In addition to the boost from capital, the recent stabilization of the net interest margin in the banking industry has also become a "catalyst" for the rise in bank stocks. Recently, data disclosed by the National Financial Regulatory Administration showed that the net interest margin of commercial banks in the second quarter was 1.54%, consistent with the first quarter, reflecting a gradual easing of the pressure on the narrowing net interest margin of commercial banks.

"The year-on-year growth rate of the cumulative net profit of commercial banks has slowed down, but the pace of decline has moderated," said the macro research team at Industrial Bank Research. In the first half of 2024, the net interest margin of commercial banks decreased by 19.50 basis points compared to the first half of 2023, and this decline was narrower than the year-on-year decline in the first quarter of 2024. This may imply that it will still take time for the fundamentals to bottom out and rebound.

What about the future outlook?

Historically, bank stocks have significantly outperformed the broader market at several points, including the end of 2006, mid-2009, the end of 2012, the end of 2014, early 2018, and mid-2021. Looking at the logic behind the rise in bank stocks in the past, the industry generally believes that it is usually reflected at the turning points of economic expectations and liquidity.

A private equity fund partner told reporters that the driving factors for the fundamentals of bank stocks are mainly two: one is asset quality, which is the most core driving factor, and the other is the high growth of credit, which is also an important driving force for high performance growth. For example, in 2009, the relative increase in the shares of joint-stock banks and city commercial banks was at the forefront, with the speed of asset expansion on the asset side being the core trading variable, and banks with high increases in infrastructure loans had relatively higher increases.

A banking industry insider said that in the short term, considering that the interest rate reduction cycle has not ended, the interest margin is still under pressure, the growth rate of credit scale is expected to slow down, and the strength of provisioning feedback is weakening, it is expected that the growth rate of bank performance will not improve in the short term.

Looking at the above two factors, the asset quality of listed banks still needs to be optimized. In the first quarter of this year, more than half of the 42 listed banks maintained the same or decreased their non-performing loan ratio compared to the end of the previous year, with Nanjing Bank having a higher decrease, with the non-performing loan ratio decreasing by 0.07 percentage points compared to the end of the previous year. However, the provision coverage ratio of some listed banks has decreased compared to the end of the previous year. This trend continued in the semi-annual reports of listed banks, and looking at the non-performing loan ratios of listed banks that have disclosed their "mid-term exam" results, 5 listed banks saw a decrease in the first half of the year, 4 remained the same as at the end of the previous year, and only Ping An Bank saw an increase.

Listed banks still face challenges in credit allocation, mainly due to weak credit demand across society. The latest financial data released by the central bank for July shows that the total social financing increment for the month was 770.8 billion yuan, which is higher than the same period last year but has fallen sharply compared to June; the RMB loan within the social financing scope even showed a rare negative growth, with a new scale of -76.7 billion yuan, which is the first negative growth since July 2005, and a significant reduction of 113.1 billion yuan year-on-year.

There are also many institutions that have a long-term optimistic view of the banking sector. Dongxing Securities banking industry researcher Lin Jinlu believes that the positive factors for the allocation of the banking sector are increasing, including the expected acceleration of the deposit cost improvement process and the expected marginal improvement in asset quality. In the medium and long term, the current trend of the interest rate center is downward, and the "asset scarcity" pressure is expected to continue, making the allocation value of high dividend assets prominent. Against the background of the expansion of passive funds and the guidance of medium and long-term funds into the market, the capital side has strong support, and the value of sector allocation is optimistic.