It has been a roller coaster ride for the finance sector in 2017. Though the year begun on an optimistic note with high expectations from President Trump’s electoral promises, it lost some steam in the middle only to regain the bullish trend at the end.
Nonetheless, the sector showed resilience given the hawkish stance by the Fed (three rate hikes in 2017) and gradually improving U.S. economy. Further, the new tax act drove the finance stocks. Also, progress on the lesser banking regulation front cheered investors.
But these positive factors don’t seem to be enough. Among the handful of finance stocks listed on the Dow Jones Industrial Average (DJIA) index, Goldman Sachs GS and JPMorgan JPM are the worst performers of 2017 with the former rising 7.1% and the latter 24.9%. Moreover, both the stock underperformed the DJIA’s year to date rally of 25.6%.
Further, this is in contrast to their 2016 performance. Goldman had surged nearly 33% and JPMorgan almost 31%. Also, these two had significantly outperformed the DJIA’s growth of more than 15%.
What Ailed the Banks in 2017?
The most important factor that hurt both Goldman and JPMorgan was the slump in trading activities during the year. Lack of volatility and low client activity continued to wreak havoc on the banks’ trading income. Though the lingering optimism from 2016 somewhat supported trading volumes in the beginning, as the year progressed it was not enough. Notably, executives of both Goldman and JPMorgan expect a similar trend to persist in the near term.
Additionally, overall demand for loans remained sluggish during the year. Specifically, mortgage loan demand was low amid a rise in interest rates as mortgage refinancing declined.
Further, there was a lesser scope to strengthen profitability-based cost saving efforts. Both JPMorgan and Goldman seem to have already slashed avoidable expenses. Therefore, the chance of cost reduction being a big supporting factor is less.
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Why the Situation May Improve in 2018?
Investment banking strength: For both JPMorgan and Goldman, 2018 is expected to be better as investment banking is expected to continue improving. With gradual stability in the capital markets, global investment banking activities are strengthening. Per the latest Thomson Reuters data, JPMorgan and Goldman hold the top two spots in the overall investment banking league table for 2017.
With continued stabilization of the global economy and lower corporate taxes under the Trump regime, M&As and bond as well as equity underwritings will witness further rise next year. So, these are expected to support Goldman and JPMorgan revenues in 2018.
Optimism surrounding higher interest rates: The Finance sector is one of the biggest beneficiaries of the rate hike. With three rate hikes this year and three more projected for 2018, both JPMorgan and Goldman are bound to gain. This also signals an improving U.S. economy.
A big change in the form of expected stimulus from implementation of the tax act may alter the Fed stance about the pace of rate increases. Also, anticipated higher inflation may lead the central bank to move the interest rate higher at a faster pace as economic growth improves further.
Traditionally, being an investment banking firm, Goldman is gradually diversifying its revenue base and undertaking efforts to boost the GS Bank's business. So, in the rising rate environment, interest income for both Goldman and JPMorgan (a traditional bank) will continue to improve.
Potentially lesser regulations: Increased regulations, since the 2008 crisis, substantially hampered growth prospects for finance stocks, with Goldman and JPMorgan not remaining untouched. But Trump’s election promise of reduction in stringent regulations is ‘work in progress.’ Though no time frame has been outlined for execution, the announcement of a bipartisan agreement has helped investors regain confidence.
Rising earnings estimates: For Goldman, over the last 60 days, the Zacks Consensus Estimate rose nearly 1% to $20.64 for 2018. The company has long-term expected earnings per share (EPS) growth rate of 12.0%.
Also, the Zacks Consensus Estimate for JPMorgan has moved up marginally to $7.73 for 2018, over the last 60 days. Currently, the company has a long-term expected EPS growth rate of 6.7%.
Therefore, looking closely at the above-mentioned factors, shares of Goldman and JPMorgan are expected to rebound in 2018.
Currently, both JPMorgan and Goldman carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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