US Q1 bank earnings preview
After a mixed first quarter, US banks face a softer outlook for interest rates and trading revenue, helping to explain their underperformance versus the S&P 500.
Investors in bank stocks have seen the sector underperform the broader market as recession fears rise and the Federal Reserve (Fed) takes a dovish turn with regard to its monetary policy. Even with dividends included, the KBW bank index has ‘only’ returned around 13% versus 16% for the broader index.
A flattening yield curve has also provided a problem for banks, as short-term rates decline and hit earnings from lending. However, the sector has become cheaper, with price-to-earning’s ratio (P/E) declining towards levels last seen in early 2016. Earnings for 2019 are expected to decline year-on-year (YoY), but not as much as feared, while the quarter-on-quarter figures are expected to be better overall.
Cautious outlook for US banks
Earnings forecasts have declined since the summer, and while this does allow for the possibility of beating expectations, it is a reflection of the cautious outlook, as investors recover from the volatility of quarter four (Q4) 2018 but also start to fret about a recession in the US in the not-too-distant future.
The outlook for rates remains soft – Fed chair Jerome Powell has already signaled that rates could be on hold ‘for some time’ thanks to weaker inflation data. Net interest income will remain flat as a result, having risen strongly over the past year (up 10% last year to $14.4 billion at JPMorgan, a record according to Bloomberg).
Q1 is likely to have been a tough quarter for trading revenue, with the period witnessing the US government shutdown. Some brokers are expecting a slowdown of at least 10% for the quarter, with these fears amplified by warnings from key executives that the year had got off to a slow start.
Loan growth is likely to be a brighter point, with an increase of around 10% across the sector expected for business lending, and consumer lending for mortgages will have been boosted by a fall in rates in Q1 that will have tempted more Americans to refinance their home loans.
Risks: from trade war to Brexit
The outlook however is still going to be the key part. The risks abound, as they did three months ago. China trade talks are still ongoing, with little sign of a resolution, while the US looks set to start a fresh conflict with the EU, providing something else to worry about. The slowdown in the eurozone may be abating, but it will take time for that region to start to improve meaningfully. Finally, of course there is Brexit, which hangs over global markets like the proverbial Sword of Damocles.
The financial exchange traded fund (ETF) for the financial sector, XLF, remains well below the highs of last year. Indeed, it has yet to push firmly above the 2700 high that marked the peak in March. Crucially, it broke through trendline resistance from the September highs back in February, and while it dropped sharply in March it found support at the previous downtrend line. A move above 2700 opens the way to 2747 and the November/December highs.
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