There's an old saying on Wall Street that it's hard to have a rally without the big banks. But that adage isn't holding true, at least from a market standpoint, as second-quarter earnings season approaches for the largest U.S. financial institutions. The stock market had a solid quarter, but big bank stocks not so much.
Relatively weak Wall Street expectations for big banks earnings possibly related to U.S. economic data and slowing net interest income (NII) could help explain the sluggish market performance for banking stocks since mid-May. NII measures the money banks make lending minus what they pay to customers and had been a forceful wind at banks' backs for two years. But now there's hesitancy about that particular metric.
At one point in late June, the Nasdaq Bank Index (BANK) was down nearly 2%, while the S&P 500® index (SPX) climbed 3% over the previous month. It's not necessarily apples to apples because the SPX's rally reflected mega caps pulling the index up even while many less powerful stocks had their wings clipped. Still, bank shares were also outperformed by industrials, utilities, and consumer discretionary benchmarks during that particular stretch and remain flat to lower since mid-May.
The lackluster showing came after a spring bank rally fizzled. Shares fell as slowing U.S. economic numbers and retreating Treasury yields led to concerns about the banks' ability to continue generating NII.
"Looking at when all those bank stocks topped out, it was about a week or two after interest rates topped out," said Kevin Hincks, senior manager of education at Charles Schwab and host of Fast Market on our media affiliate, the Schwab Network. "Banks make money off NII, and when rates go down, they make less. Banks store money, so NII is a windfall for any company that stores money. They can all do better with higher rates."
The benchmark 10-year Treasury note yield (TNX) peaked at just above 4.73% in late April before dropping to near 4.3% by late June. Hopes for a September Federal Reserve rate cut grew during this time thanks in part to cooler U.S. inflation readings and foreign central bank rate cuts, but all that also accompanied signs of pain in the U.S. economy. It's too early to call that data a trend, but it has some investors worried about U.S. growth and how it might play into the bank industry's outlook.
"Obviously, a healthy economy helps banks because money is moving," Hincks said. "More people are employed, money is moving in and out of accounts, and higher credit card balances are held by the banks. They want more transactions, and any fear of recession would hurt banks."
Analysts' estimates suggest concerns
While banks that are focused most on trading like Goldman Sachs (GS) and Morgan Stanley (MS) have high revenue and earnings growth baked in, the same isn't true for all. JPMorgan Chase (JPM), Bank of America (BAC), Wells Fargo (WFC), and Citigroup © aren't expected to post particularly powerful quarters, according to analysts' estimates collected by Yahoo Finance.
Beyond the biggest banks, analysts also don't project meteoric Q2 earnings growth for the broader financials sector, despite an improved overall earnings picture for the U.S. stock market as a whole versus Q1. The financials sector includes big banks, regional banks, credit card companies, and insurers.
As of late June, research firm FactSet pegged Q2 S&P financials sector earnings per share (EPS) growth at 5.2%, well below the 9% expected for S&P 500 companies overall. Revenue growth for financials is seen at 2.8% compared with overall S&P 500 revenue growth of 4.6%.
Even so, the biggest banks might have a surprise up their sleeves—they have overcome low expectations before. Back when Q1 earnings season began in April, analysts projected less than 2% EPS growth for financial companies, according to FactSet. The sector ended up delivering EPS growth of 7.7%, which is above S&P 500 EPS growth of 5.9% that quarter. Sector revenue growth of 7.2% also beat the overall 4.2% revenue growth for the broader market. Analysts had expected only 3.2% revenue growth from financials.
"There are worries about recession, but these banks still seem to be firing on all cylinders," Hincks said. "But what are they going to guide for the second half of the year with the U.S. consumer? If they talk about ongoing consumer weakness, the market won't like it, and neither will the banks' stock prices. Could they come out with good numbers and guide weaker? Yes. If they think rates are going lower, the stocks may sell off."
As of late June, investors built in a 65% chance of a 25-basis-point Fed rate cut by the Federal Open Market Committee's (FOMC) September meeting, according to the CME FedWatch Tool. Odds are about the same that the Fed will follow up with another cut later in the year. Interest rates remain at two-decade highs with the Fed's target range set at 5.25% to 5.5% since last July.
Big banks' ability to surprise could depend on whether they manage to keep up the strong trading and investment banking results seen in Q1. That quarter featured Goldman Sachs, JPMorgan Chase, and Morgan Stanley reporting solid numbers in those categories, while all six of the country's largest banks topped analysts' earnings and revenue expectations. Those six include the three mentioned above as well as Citigroup, Bank of America, and Wells Fargo, all of which report Q2 results in the coming days.
Investment and trading revenue is only part of the equation, however. NII, which swelled for many banks over the last year as interest rates rose, also likely needs to keep providing a boost. As noted above, that's in question.
Last quarter, JPMorgan Chase's guidance raised concerns about future NII. NII declined 4% sequentially in Q1 to $23.2 billion, and in its press release, JPM cited "deposit margin compression." This means a narrowing gap between what it makes in interest and what it pays out. It added it expects "normalization to continue for both NII and credit costs." The company guided for $90 billion in 2024 NII, stable with its previous estimate and disappointing investors who'd expected a rise. Normalization, in this case, would not be a good thing, necessarily, considering how much JPM and other big banks benefitted from last year's lofty NII.
While JPM is just one company, its massive market capitalization of more than $570 billion as of late June gives it broad influence across the sector, meaning its quarterly results can influence the path of the entire financials sector. If JPM struggles with NII, it's possible other large banks might too. NII fell sequentially at Citigroup in Q1, and the company guided for lower full-year NII excluding its market segment. NII also fell at Bank of America in Q1.
Beyond net interest income
NII has been a nice tailwind for banks, but it tends to fluctuate over time depending on the path of interest rates. That means banks still need to focus on basic blocking and tackling to keep their businesses growing, including attracting deposits, making loans, and profiting from trading and other market activity like mergers and acquisitions (M&A) and initial public offerings (IPOs). Those things actually grow in importance once banks can't lean so much on NII to make their numbers.
That's why those results could get a closer look from investors this coming quarter and in quarters to come. Recent declining economic data raise questions about how banks can meet expectations across those metrics, though one month of slower readings isn't enough to represent a trend.
The economy is a wild card for banks the rest of the year. On the one hand, if the Federal Reserve cuts rates later this year, it could support certain business activities like M&A, as well as increase general borrowing demand from consumers and businesses. These are areas where banks can make money, and both have been suppressed by the current high interest rates.
On the other hand, a weaker economy and lower rates could hurt NII, though the best-run banks have found ways to profit whether rates are high or low, Hincks noted. A weak stock market, if it accompanies weak economic growth, might not be so helpful for trading and wealth management businesses at banks and could also diminish demand for IPOs. However, the IPO market has had its best first half of a year since 2021, CNBC reported.
Six key banks are scheduled to report in the next week, starting on Friday, July 12 with JPMorgan Chase, Citigroup, and Wells Fargo delivering results that morning, according to Earnings Whispers. Goldman Sachs follows on Monday, with Bank of America and Morgan Stanley wrapping things up on Tuesday.
Things may improve for the sector as the year continues, with financials pulling ahead of the S&P 500 for the full year in terms of projected earnings growth. Financial earnings are seen rising 12.8% in 2024, outpacing an expected 11.3% S&P 500 EPS growth for the year, FactSet said in late June.
CEO economic outlook under a microscope
Earnings season for the biggest banks offers investors a chance to hear CEOs' perspectives on the credit market for consumers and businesses as well as their broader take on the possible path of the U.S. economy. Friday's JPMorgan Chase earnings report will include views from the bank's CEO Jamie Dimon, whose outlook can sometimes move the market.
"Dimon could potentially talk about the odds of a recession," Hincks said. "A lot will trigger off of what Dimon says. Banking sets the tone for the earnings season because they're the first to come out. They've had such a great run, but that means there's a high bar to clear. Any hesitation or weakness in guidance could hurt."
When the big banks report, keep an eye on each institution's general level of loan activity and the quality of their existing loans. Banks still have a good deal of outstanding loans on their books due for refinancing this year. With rates much higher now than a few years ago, businesses and households could remain wary about renewing or taking on new debt. The mortgage market is a good example.
Additionally, when yields stay relatively high, banks must pay more to clients to keep money in their accounts. Falling yields at the end of last year and hopes for rate cuts raised optimism that banks might face less pressure. The much lower anticipated rates never showed up, thanks to stubborn inflation.
Another item to watch is loan loss provisions, or the funds banks put aside in case loans go bad. These detract from earnings and have been a near-constant drag on bank results since they began adding to these reserves during the pandemic. One question is whether hopes for lower borrowing costs could make banks feel safe keeping levels where they are.
Though big banks get much of the attention, smaller regional banks begin reporting next week too and might provide investors more insight into the small businesses and consumers that form much of their customer base. With small-cap stocks struggling this year, commercial real estate still sluggish, and growing worries about an overextended consumer, small banks shouldn't be ignored.
"There's a huge performance gap year to date and a smaller performance gap quarter to date, but a gap nonetheless," said Collin Martin, director of fixed income strategy at the Schwab Center for Financial Research. "Commercial real estate (CRE) is still weighing on the small banks given the higher for longer interest rate theme and the headlines creeping in on CRE defaults."
For the major banks reporting Friday, analysts expect the following, according to Yahoo Finance:
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JPM EPS of 4.72, down slightly from the same quarter a year earlier, on revenue of $43.9 billion, up 3.6% year over year
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WFC EPS of $1.28, up 2% from a year earlier, on revenue of $20.23 billion, down 1.5% from a year ago
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C earnings of $1.39 per share, up 4.5% from a year ago, on revenue of $20.08 billion, up 3.3%
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