Investors eye Washington for Big Bank outlook

Trading down

Do earnings matter for big U.S. banks right now? We will know for sure over the coming days. Bank of America, Citigroup, Goldman, JPMorgan, Morgan Stanley and Wells Fargo release third quarter reports this week and next. Even beforehand however, American lenders roundly damped expectations of strong earnings support from trading revenues, yet the financial sector has still outperformed the broader market for around a month. The S&P Financial index, dominated by the ‘bulge-bracket’ names above, sold off hard from a peak in March leaving the sector almost 2% in the red for the year by April. A similar downdraft capped financials’ attempted comeback over the summer. But external support for banks has never been too far round the corner this year. When it looked like the Trump administration’s plans for tax cuts and regulatory reform were more in the balance than now, bond yields rallied to pick up the slack. Switches in preferred market style from ‘growth’ to ‘value’ and back also favoured banks, for a time. As shown by the normalised chart below, the S&P Financial Sector’s rally over three months to the end of last week powered a strong rebound from a July-September down leg. This enabled banks to largely catch up with a market they have lagged for much of the year.

Figure 1 - S&P 500 vs. S&P 500 financials rebased (3 months)

Source: Thomson Reuters and City Index

Fed supervisor on site

It’s almost as if weak loan growth, glacial improvements in net interest margins and a capital market rebound earlier in the year that petered out, don’t matter that much. Investors are indeed more optimistic over potential for reduced financial regulation. Prospects of such have returned to the fore simultaneously with taxation hopes, particularly after the Senate last week confirmed Randal Quarles as the Fed’s first vice-chair for supervision. A Treasury Dept. official during George W. Bush’s presidency, Quarles’s recent comments echo the White House’s push for financial deregulation.

A blueprint and more waiting

Whilst doubts remain about the timeline for any tax or financial reform, investors have priced the potential positive impact back into the sector nonetheless. A ‘blueprint’ which Congress voted in favour of last week is unlikely to make substantive progress into law until late in 2018, at the earliest. Lingering uncertainty on taxes and regulation thereby leaves banks with little to fall back on should they fail to match forecasts of modest Q3 growth. We would expect a rise in volatility of the stock of any bank that disappoints. On the other hand, since Wall St. is most pessimistic on Goldman Sachs’ earnings, should the fifth-largest U.S. bank by assets surprise to the upside, it could rally more sharply than rivals. We outline expected Q3 growth for each of the ‘Big 6’ lenders below.

Table 1 – ‘Big 6’ banks Q3 earnings forecasts, dates

Source: Thomson Reuters and City Index