Idea of the Day US banks can JP Morgan make a fresh record high

What: From this Friday 14^th July, US banks will release Q2 2017 earnings data. The first to announce results on Friday are Wells Fargo, JP Morgan and Citigroup, with Morgan Stanley and Goldman Sachs releasing results on Tuesday. The backdrop to these earnings is fairly mixed. On the one hand the Federal Reserve has recently cleared the capital return programme, allowing 34 US banks to go ahead with share buybacks and dividend increases after the most recent round of bank stress tests. This has triggered Citi and JP Morgan to increase their dividend, with the latter also announcing a share buyback plan. The fundamental back drop is also sound with gradual rate increases from the Federal Reserve and strong jobs growth, all good news for the banks. However, analysts have been downgrading their estimates for US bank earnings for most of this year. For example, the market now expects JPM Earnings-per-Share (EPS) to come in at $1.53, which is 1.9% lower than the EPS estimate was 4-weeks ago. Likewise JP Morgan’s revenue estimates and net income estimates have also been downgraded in recent weeks.

The big problem for banks, particularly the investment banks, has been the lack of volatility in the markets which could limit profitability for Q2. Over the period the Vix index, a measure of volatility in the S&P 500, has averaged 11.43, which is close to historic lows. This is likely to impact the banks with the largest investment banking divisions, including Citi, Goldman Sachs and Morgan Stanley, while JP Morgan and Bank of America, although they have large IB divisions, also have large retail banking units, which could limit the potential bad news in  trading revenue.

One pocket of strength for the largest US banks could be the upbeat market view about US companies with high levels of foreign sales. Banks come into this category so they may benefit from the recent weakness in the dollar, although this hasn’t stemmed the downgrade in earnings estimates for this sector.

The big question for traders is whether the bar for US bank earnings last quarter is too low, if so then a couple of better than expected earnings figures could see the sector shine again.

How: The S&P 500 investment banking sector index peaked in March of this year before falling back in the two months’ to May. Although it has staged a decent recovery since June, it has not managed to get back to the March high at 154.89. We believe that if analysts have been too gloomy on this sector, and earnings come in above estimates, then we could see a return to the yearly highs from March.

JP Morgan’s earnings, and especially its H2 guidance will be critical for the overall US banking sector because of its sheer size in the industry. JP Morgan have set expectations for a 10-15% drop in trading revenues relative to 2016, a lower than expected drop in revenues would be perceived as good news for the entire sector, while a larger decline would be bad news for investment banks. Forward guidance from JP Morgan on loan growth, especially the weak auto loan sector in the US, regulation and tax policy and the impact of Brexit will also be watched closely.

JP Morgan’s share price has enjoyed a strong rally since it announced its dividend increase and share buyback programme, however, it stalled at $94.51, its highest ever level. If the stock is to clear this resistance level and continue to break into fresh record territory above $95, we may need to see a surprise in earnings. This is a tall order for JPM, but one this bank could reach, since it has beat earnings estimates 6 out of the last 8 releases.