Stocks still buoyed by bank hopes

Summary

Much of the optimistic sentiment stock markets are reflecting on Friday hangs on earnings from three of the largest U.S. banks that will be released shortly.

Banks in focus

With trade headwinds still contained investor focus looks ahead to the highlight for the week, the release of earnings from the largest two U.S banks by assets and revenues JPMorgan and Wells Fargo. Beyond the importance of their earnings for the pivotal lenders themselves, the reports will also serve as the starting block for the corporate reporting season. Expectations are high, and for dominant U.S. banks at least, prospects are solid in view of rising rates, and unabated improvement in inflation, output, growth and the labour market in the first half of the year. This helps account for Wall Street’s expectation of a 21% advance in earnings growth for financials in Q2, and a close to 21% from all S&P 500 companies as a whole.

Citigroup earnings may lag

The swell won’t lift all boats though. Citigroup, the fourth-largest U.S. bank by total assets will also report Q2 earnings on Friday. It is also the weakest in terms of deposit growth, adding $$453m so far in 2018, less than half the amount of any of its three main rivals. That’s due to a retrenchment that saw it close branches in most U.S. cities, aiming to save costs and looking to grow online instead. However, the strategy has hampered the group’s ability to meet financial targets and left profitability lagging key rivals. A trickle of recent Wall Street forecast downgrades on Citi’s earning has continued this week. To an extent, that has mirrored increasing caution on Citi’s peers JPM, Wells Fargo, Goldman and Bank of America. So some wariness is coming through about recent and current performance by Citi and its competitors. Citi is expected to report earnings of $1.56 per share in Q2 , a 22% rise on the year. JPMorgan is forecast to report EPS of $2.21, up 21.7%, Wells’ Q2 EPS is seen at $1.12, 4.5% better on the year.

Reasons to be cautious

The outcome of any ‘misses’ across these closely watched results would be predictable for shares. With broader sentiment still keeping an eye on recent ripples overseas, caution has been discernible near the surface of stock market gains this week. It is also worth keeping in mind further potential after-effects of last year’s tax legislation changes that could poke some holes in companies’ quarters. For instance, PepsiCo reported better than forecast earnings earlier this week, but kept guidance unchanged. An additional “transition tax expense” of $777m may have been partly responsible for the static outlook. Some larger than anticipated or entirely unexpected negative effects are possible elsewhere. These or other unwanted surprises could compound caution about the outlook for the rest of the year due to geopolitical uncertainties and it may not take much for the market to beat a late week retreat. With the S&P 500 retaking its first gains for the month just yesterday, in a fallow year at that – the index is up just 4.3% in 2018 – sustained investor confidence matters rather more than usual right now.

Expectations more modest in Europe

With earnings expectations in Europe more modest, resignation could be even swifter in the event of disappointment in coming weeks. Removing the volatile effect of energy-sector earnings, the Thomson Reuters I/B/E/S consensus forecast is for an aggregate net income rise of around 3% for STOXX 600 companies in the second quarter. (Energy firm earnings lift the forecast to 8%). Underlying expectations are trending lower from high points in the mini cycle around 9%. Aside from chronically sluggish earnings amongst utilities and large telecoms, dips in technology, and healthcare sector earnings should also be a worry. The modest pick-up in growth forecast at European financials (+7%) could also be vulnerable to the seemingly interminable stream of one-off effects large banks have reported for years.

Reasons to stay optimistic

Even European and U.S. indices with a heavy oil weighting are shrugging off Brent’s 7% fall this week though. So, absent major negative surprises, earnings optimism that is continuing to underpin indices and U.S. futures on Friday can carry sentiment into a positive close. A tight range in Treasurys trading this week that provides manageable optics on borrowing costs also helps. It’s another session in which the inevitability of the greenback’s advance has been difficult to ignore. On the other hand, it has been possible to pin much of the Dollar Index’s fourth-largest weekly stride in two quarters on Brexit news. The struggle of the risk barometer yen to hold gains has also smoothed perceptions. Traders are therefore watching its current bid against the euro carefully. Sterling could stay capped under late $1.32s after the U.S. President dismissed Downing Street’s Brexit blueprint. The euro could remain similarly adrift against the dollar, though that’s balanced by strength across Nordic crosses and the pound.