Friday, July 12, 2013
J.P. Morgan (JPM) and Wells Fargo (WFC) kicked off the second quarter earnings season for the banking sector with very strong reports this morning. The earnings growth outlook for the Finance sector has been the only bright spot this earnings season and reports from these two banks provide us with a solid start to the Q2 reporting season for the sector.
We will know more next week as a ton bank earnings reports arrive, including from Bank of America (BAC), Citigroup (C), Goldman Sachs (GS) and the regional players. A read-through from these two reports paint a favorable picture for bank earnings, even though a straight extrapolation from these two banks to the rest of the group may not be appropriate.
The Finance sector has been amongst the few in the S&P 500 that experienced positive estimate revisions in the recent past even as estimates for most other sectors, particularly Technology, Basic Materials, and Industrials got cut. This makes sense given Finance’s domestic cyclical orientation and the improving growth outlook for the U.S. economy. The sectors experiencing negative estimate revisions, Technology in particular, is not only faced with secular headwinds, but also have outsized exposure to a growth challenged international environment.
The recent rise in long-term interest rates is a net positive for banks as it helps expand their net interest margins, even though the very sudden and sharp spike could potentially result in major losses on bond holdings on the balance sheet. We didn’t see any unusual negative trading effects from this morning’s JPM and WFC reports, but that doesn’t mean we may not see the same from other players next week. Another area where rising rates could potentially become problematic for banks is in mortgage banking, particularly on the refinancing side. The refinancing slowdown will become more evident in next quarter’s results, but banks could potentially offset a drop in the refinancing activity through increased originations as we saw with this morning’s reports. Importantly, credit quality improved at both the banks, with loan-loss provisions and net charge-offs coming down.
Including the reports from J.P. Morgan and Wells Fargo, total earnings for Finance are expected to be up +21.3% from the same period last year, the strongest performance of any of the major sectors within the S&P 500; the Construction sector is expected to have +46.5% total earnings growth in Q2, but that sector is way too small to move the needle for the index as whole. There is not much growth outside of Finance, with 9 of the 16 Zacks sectors expected to show negative earnings growth in Q2. Earnings growth for the S&P 500 as a whole is expected to be +0.7% in Q2, but the growth rate turns to a decline of -3.4% outside of the Finance sector.
This is still very early in the reporting cycle, as we have Q2 earnings reports from only 29 S&P 500 companies as of this morning. The growth rate will almost certainly improve as more companies report – we have 76 S&P 500 companies on deck to report results next week. But more important than the Q2 earnings growth rate will be management guidance for the coming quarters that will determine expectations for second half of the year. As we have mentioned here in the past, expectations for the second half of the year reflect a strong rebound in overall earnings growth, with total earnings for the S&P 500 expected to be up +4.8% in Q3 and +11.4% in Q4.
As this morning’s negative pre-announcement from UPS (UPS) shows, those estimates will need to come down. It will be interesting to see if the stock market can sustain its bullish momentum in the face of negative estimate revisions in the coming days, particularly if the Fed will be playing a less supportive role going forward.
Sheraz Mian
Director of Research
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