Decent Bank Results Drowned Out by China & Oil

The New Year has been tough on all stock market sectors. But the bank sector sell-off has been the most disappointing given earlier hopes of their leverage to the Fed tightening cycle. The extended period of low interest rates had effectively robbed banks of their pricing power and the expectation was that a steadily rising interest rate environment will help restore the industry’s power. But that happy narrative has fallen victim to the market’s evolving view of China and the oil market, which has a bearing on the market’s Fed expectations, and as a result interest rates. U.S. treasuries’ safe-haven status is at play in the flattening yield curve as well.

Needless to say that this has been a very unfriendly backdrop for Q4 results from the banking leaders, which have by and large been good enough. No one expected fireworks from J.P. Morgan (JPM - Analyst Report), Wells Fargo (WFC - Analyst Report) and Citigroup (C - Analyst Report) – we knew capital market and underwriting revenues would be weak, net interest margins would be flat at best and core loan portfolios would show some modest gains. Relative to these admittedly weak expectations, they did pretty well, with gains in loan portfolios particularly encouraging. The Citigroup report was somewhat ‘noisy’ that made it difficult to get a good handle on core business, but the J.P. Morgan and Wells Fargo reports reconfirmed why those two banks are the undisputed leaders in this space.

We have plenty of read-throughs from these reports to next week’s results from Goldman Sachs (GS - Analyst Report), Morgan Stanley (MS - Analyst Report) and Bank of America (BAC - Analyst Report). Overall, the going was tougher for the brokers in Q4, and that’s what we will see in the Goldman and Morgan Stanley reports. But the Bank of America report should show most of the positive elements we saw in the J.P. Morgan report. We should expect many of the regional operators that will be reporting in the coming days to show similar momentum in their loan portfolios.

Another issue of lingering concern for the market is the sector’s oil exposure, with many people fearing a replay of the housing downturn of 2008. We saw that J.P. Morgan, Citi and Wells Fargo acknowledged the overhang and provisioned for the eventual losses from their oil loans. We will see this same treatment with Bank of America as well. This could be a major drag for some of the smaller regionals, but this is unlikely to be anywhere as consequential for the major banks as housing was during the crisis.

Banking Scorecard

The ‘Major Banks’ industry, which includes all the major money-center banks like J.P. Morgan and Citigroup, is one of six medium-level industries in the Finance sector and accounts for roughly 42% of the sector’s total earnings. At present, we have Q4 results from 5 of the 15 major banks in the industry, which combined account for 68.9% of the industry’s total market cap. For the Finance sector as a whole, we have Q4 results from 7 of its 85 members that combined account for 27.2% of the sector’s total market cap.

Total earnings for these Finance sector companies that have reported results are up +25.8% on +1.4% higher revenues, with 71.4% beating EPS estimates and 85.7% beating revenue estimates. The table below shows the sector’s Q4 scorecard at the medium-industry level.

Please note that while the outsized earnings growth (+25.8%) at this stage is thanks to easy comparisons at Citigroup, this is still better performance than we have seen from these banks in other recent periods even on an ex-Citi basis. The charts below compare the sector’s results thus far with what we have seen from the same group of companies in other recent periods. As you can see, the growth rates and beat ratios are tracking notably better at this stage.

Looking at the growth comparison on an ex-Citi basis (below) still shows that banks are doing better relative to the recent past.

We will see in the coming days if banks can sustain this initial performance momentum, but it is nevertheless a good start. The fact that bank stocks aren’t reflecting this improved performance momentum is largely a function of the macro headwinds that we touched on at the top.

Q4 Scorecard (as of Friday, January 15th)

With Q4 results from 32 S&P 500 members already on the books, total earnings are up +9.3% on +3.5% higher revenues, with 71.9% beating EPS estimates and 43.8% coming ahead of top-line expectations. As mentioned earlier in the context of the Finance sector’s results, easy comparisons at Citigroup are a big factor is the strong earnings growth pace. Excluding Citigroup, total earnings for the other 31 index members that have reported results would be down -1.3% from the same period last year on +3.7% higher revenues.

The table below provides the current Q4 scorecard

The charts below provide a comparison of the results thus far with what we have seen from this same group of 32 S&P 500 members in other recent periods.

 

Given the ‘distortions’ in the growth pace at this early stage, the only usable comparison is the beat ratios. The beat ratios are tracking a bit on the weak side at this stage, but not in a big way.

We have 129 companies reporting results this week, including 39 S&P 500 members.

The chart below shows the weekly summary reporting calendar for companies in the S&P 500 index.

What is expected for Q4?

Total earnings for the S&P 500 index are expected to be down -7.3% from the same period last year on -4.6% lower revenues, the third straight quarter of earnings declines for the index.

While Energy remains the big drag, as it has been in other recent quarters, the weakness is broad-based, with 13 of the 16 sectors expected to suffer earnings declines. Total earnings for the Energy sector are expected be down -70.6% on -37.7% lower revenues. Excluding Energy, earnings growth for the S&P 500 would still be in the negative (down -1.8% on -0.2% lower revenues).

The table below provides a summary picture of Q4 expectations contrasted with what was actually achieved in the preceding quarter.

Please note that the growth picture is actually even weaker once Finance’s respectable-looking +6.8% growth in Q4 is adjusted for the easy comparisons at Citigroup. Excluding Citigroup, the Finance sector’s growth effectively becomes flat (up only +0.8%).

Bigger Drop in Q4 Estimates

As has been the practice in recent quarters, the overwhelmingly negative tone of company guidance drove down expectations for the quarter. The chart below does a good job of showing the evolving Q4 earnings expectations over the last few months.

The trend of negative revisions to Q4 estimates is right along the lines of what we have been seeing repeatedly in other recent periods. But the magnitude of negative revisions that Q4 estimates suffered is bigger than what we saw in other recent quarters in the comparable period. In other words, estimates for Q4 fell more in the three months since the start of the quarter than the comparable periods of other recent periods.

What could be behind the acceleration in the negative revisions trend for Q4?

A big part of the explanation comes from the Energy sector, with oil prices coming down since October 1st. The weakness in oil (as well as natural gas) prices have been weighting on Energy sector earnings estimates since the start of the quarter, with earnings for the sector now expected to be down –70.6%, which compares to the –62.5% decline expected on October 1st.

Other factors that have been weighing on the earnings picture this year from the strong U.S. dollar to global growth worries have also remained in place, though they didn’t become any bigger than issues than was the case earlier in the year.

Looking Beyond 2015 Q4

The chart below shows 2015 Q4 growth expectations in contrast to what was achieved in the preceding the two quarters and what is expected in the following four quarters.

As you can see above, the negative growth trend carries into the first quarter of the New Year, with total earnings for the quarter currently expected to be down -2.5% from the same period last year. Going by recent history, we can say with a lot of confidence that the -2.5% decline in Q1 will most likely get bigger in the coming days as companies report Q4 results and guide lower; the -7.3% decline in Q4 earnings is down from -1.1% decline expected at the start of the quarter in early October.

The growth trend is expected to pick up in the back half of the year, with growth really accelerating in the last quarter of the year. The relatively optimistic looking expectations for the outer periods aren’t unusual – Wall Street analysts always tend to be more optimistic about the future. But estimates start coming down as the period in question comes closer. The erosion of 2015 growth estimates was driven largely by what happened to the Energy sector. But estimates for other sectors came down as well...and we will likely see something similar to current 2016 estimates as well.