(Bloomberg) — Bank stocks just finished their best quarter since 2021 and are heading for a high-risk earnings showdown as Wall Street's most influential executives give investors their latest take on the U.S. economy.
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JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. open the reporting cycle for Corporate America on Friday after an index of U.S. bank stocks rose 23% in the latest quarter, outperforming the broader market .
Bank stocks were under pressure for much of 2023 and then rose sharply starting in late October as confidence grew that the Federal Reserve would end its interest rate hike campaign without triggering a recession. Now the focus is on the timing of monetary easing, and investors will be examining what this means for all areas of lenders' businesses, from the health of their loan portfolios to the outlook for deposit rates.
“Banks are obviously not as cheap as they used to be, but at the same time I don't think people think that bank valuations are stretched,” said Richard Ramsden, an analyst at Goldman Sachs Group Inc.
If banks are more optimistic than expected about net interest income, loan growth, capital markets and deposit prices, “that will obviously all be reflected in higher earnings and probably further relative outperformance by some banks,” Ramsden said.
The KBW Bank Index fell about 1% on Thursday, underperforming the broader market, which ended the day largely unchanged.
Read more: Top US banks hope to ease interest rate pressure after Fed rate hikes
On Tuesday, attention will turn to earnings from Morgan Stanley and Goldman Sachs. The first results from regional lenders will also be released that day, with PNC Financial Services Group reporting, making it an indicator for regional lenders.
The story goes on
Major banks are widely expected to report poor fourth-quarter results due to higher funding costs. The sector's net interest income is expected to fall, while higher expenses and weak trading income are also likely to weigh on earnings, Goldman's Ramsden said in a report. Loan growth is expected to be modest, he said.
The companies are also expected to make payments to the Federal Deposit Insurance Corp. detail the consequences of the regional bank failures that rocked financial markets early last year. Citigroup said Wednesday that it expects to incur $1.7 billion in costs to replenish the FDIC fund. Meanwhile, Bank of America said it would charge a $1.6 billion fee related to the Libor transition.
The tide is turning
Bank stocks turned the tide last quarter as the prospect of Fed rate cuts in 2024 eased concerns about areas such as net interest margins.
“Most major bank stocks staged a strong year-end rally, driven by confidence that their profitability would not suffer a major hit as recession risks have sharply diminished,” said David Bianco, chief investment officer for the Americas at DWS Group. “The risk for larger banks of making large provisions for loan losses or having to write down securities is now much lower.”
There are many reasons for caution. Inflation remains well above the Fed's target and markets are betting on a more aggressive rate cut than the Fed is signaling. JPMorgan Chief Executive Officer Jamie Dimon said this week he remains skeptical that the Fed's rate hikes will be successful in curbing inflation without ultimately slowing the economy.
Some analysts are advising investors to curb their enthusiasm.
At BMO Capital Markets, James Fotheringham downgraded a handful of U.S. banks and specialty finance firms amid the rally, warning that they were vulnerable to an “imminent” credit cycle. Meanwhile, analysts at UBS Group AG pointed to the risk of “wild mood swings.”
“January earnings season could accelerate the sector’s recent momentum,” UBS’ Erika Najarian wrote in a note this week.
Over the past four weeks, hedge funds have sold the financial sector on average, with average weekly outflows of $200 million, while institutions and retail clients were also net sellers, according to Bank of America Corp. compiled data.
Still, financial companies were the only sector where the majority of analysts' earnings revisions were upward last month, according to data from Citigroup Inc.
DWS's Bianco said he remains overweight on major banks such as JPMorgan, Bank of America, Citigroup and Wells Fargo due to their robust profitability. Credit has been stable, he says, offsetting a slump in global transaction fees, and a pick-up in IPOs has brightened the outlook.
– With support from Elena Popina.
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