The biggest rise in bank stocks since 2021 raises the level of profits

(Bloomberg) — Coming off their best quarter since 2021, banking stocks are poised to face high-stakes earnings as Wall Street's most influential executives offer investors their latest take on the U.S. economy.

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JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. began the Corporate America reporting cycle on Friday, after a gauge of U.S. bank stocks rose 23% last quarter, outperforming the broader market.

Bank stocks had been under pressure throughout most of 2023, then rose starting in late October as confidence grew that the Fed would end its rate-hiking campaign without triggering a recession. Now the focus is on the timing of policy easing, and investors will be examining what that means for all corners of lenders' businesses, from the health of their loan portfolios to the outlook for deposit rates.

“Clearly banks are not as cheap as they were, but at the same time I don't think people think bank valuations are overvalued,” said Richard Ramsden, an analyst at Goldman Sachs Group.

Ramsden said that if banks were more optimistic than expected about net interest income, loan growth, capital markets and deposit pricing, all of that would clearly lead to increased profits and perhaps more relative outperformance for some banks.

The KBW Bank Index fell nearly 1% on Thursday, underperforming the broader market, which ended the day largely unchanged.

Read more: Major US banks eager to ease interest rate pressures after Fed hike

On Tuesday, attention turns to earnings for Morgan Stanley and Goldman Sachs. The day also brings the first results from regional lenders, with PNC Financial Services Group reporting, making it a leader for regional lenders.

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Major banks are generally expected to report downbeat fourth-quarter results amid rising funding costs. Goldman Sachs's Ramsden said in a report that it appears the sector's net interest income will decline, while higher expenses and weak trading revenue are also likely to weigh on earnings. He said loan growth may be modest.

The companies are also expected to submit details of payments to the Federal Deposit Insurance Corporation resulting from the regional bank failures that rocked financial markets early last year. Citigroup said on Wednesday it expects to take on a $1.7 billion cost to replenish the Federal Deposit Insurance Corporation (FDIC) fund. Meanwhile, Bank of America said it would take a $1.6 billion charge associated with the Libor transition.

The tide has turned

The tide turned to bank stocks last quarter as the prospect of a Fed rate cut in 2024 eased concerns about areas such as net interest margins.

“Most big bank stocks saw a strong year-end rally fueled by optimism that they would not take a major hit to their profitability given that recession risks had largely diminished,” said David Bianco, chief investment officer for the Americas at DWS. group. “The risk of big banks taking large provisions for loan losses or having to write down securities is much lower now.”

There are plenty of reasons to be cautious. Inflation remains well above the Fed's target, and markets are betting on a more aggressive path to rate cuts than the Fed is indicating. JPMorgan CEO Jamie Dimon said this week that he remains skeptical that the Fed will succeed in raising interest rates in taming inflation without ultimately shrinking the economy.

Some analysts advise investors to moderate their enthusiasm.

At BMO Capital Markets, James Fotheringham downgraded a handful of US banks and specialist finance companies on the back of the rally, warning that they appear vulnerable to an “imminent” credit cycle. Meanwhile, UBS Group AG analysts pointed to the risk of “violent fluctuations in sentiment.”

“January’s earnings season may represent a quick bump in the sector’s recent momentum,” Erica Najarian of UBS wrote in a note this week.

Over the past four weeks, hedge funds on average have been selling the financial sector, with average weekly inflows of $200 million, while institutions and retail clients were also net sellers, according to data compiled by Bank of America Corp.

However, looking more broadly, over the past month, financial companies were the only sector where the majority of analyst earnings revisions were bullish, according to Citigroup data.

DWS's Bianco said it maintains an overweight position in major banks including JPMorgan, Bank of America, Citigroup and Wells Fargo due to their strong profitability. He says credit has been stable, offsetting a decline in global deal-making fees, and a rise in initial public offerings has brightened the outlook.

– With the help of Elena Bubina.

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