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US bank earnings – a tough outlook

It doesn’t look like it’s going to be a particularly encouraging earnings season for US banks. Stock markets in the US are at all-time highs, leaving little room for the sector to disappoint, since any sour news from the banks would likely cause the market to head rapidly lower.

JPMorgan exterior logo
Source: Bloomberg

Having solidly outperformed the broader S&P 500 since July 2011, the index took a heavy tumble at the beginning of the year, and remains below the S&P 500 as the latest reporting period gets underway. Year-to-date, the S&P 500 is up 5.3%, with the banking sector down 10.7%. A contrarian view might suggest that better numbers from the sector might cause some of that underperformance to reverse, at least in the short-term.

Banks have been particularly exposed to the fallout from the UK’s Brexit vote at the end of June, but they are also acutely sensitive to the US economy, with weaker growth in the second quarter providing cause for concern. Thus, this earnings season could see them hit on two fronts, with only the second factor dropping away as the sector looks ahead. Brexit is a problem that will stay with us all for a long time to come, so we should brace ourselves for the topic to come up again and again in future earnings seasons.

A third factor to remember is that US interest rates are not going anywhere fast, at least based on current economic data and current expectations. A rise in rates would have improved lending margins, while a world without Brexit may have seen higher activity in trading, underwriting and M&A, which would have helped fees.

There may be one bright spot for the US banks, and it comes from American loan growth figures. If lending margins are not improving, at least the volumes of lending has been increasing. This is a function of the relative health of the US economy, and at least provides one area of hope. Year-on-year, average lending growth has been 5.2% over the past 25 years, but in the second quarter, it hit 7.2%.

JPMorgan takes its place at the head of the queue for US banks, reporting on 14 July. Earnings are forecast to fall 4% on an adjusted basis while revenue holds relatively steady. It currently has a forward 12 month P/E of 10.77, with an average move of 2.3% on the day earnings are announced.

Citigroup and Wells Fargo report on Friday. The former is expected to see a hefty 24% drop in adjusted earnings, while revenues are forecast to drop 8.4%. A forward P/E of nine makes it even cheaper than JPMorgan, but this might fall into the ‘value trap’ category. The stock usually sees an average move of 3.2% on the day itself.

Wells Fargo, by contrast, is expected to see revenue growth of 2.9%, although adjusted earnings are still expected to see a 2% drop. The stock is the least volatile of the three on earnings day, with an average move of 1.4%. At 11.8 times forward earnings it is the most ‘expensive’ of the bunch, although all three are well below the 16.1 times earnings multiple projected for the S&P 500 in 2017. With its high focus on the US economy and relatively small exposure to the UK and thus to Brexit, it may well look the most attractive (it has fallen by 11.3% so far this year, versus 16% for Citigroup and 4.8% for JPMorgan, although over five years it has risen by 70%, versus 3% and 54% for the other two respectively).

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