Bank stocks have experienced a fairly dramatic turnaround since the beginning of last month, with a number of major bank stocks trading at or near their highs for the year. The Zacks Major Banks industry, which includes all the money-center banks and big regionals like JPMorgan (JPM - Free Report) and PNC Financial (PNC - Free Report) that kick-off the Q2 earnings season for the industry on Friday July 14th, is now up +7%on the year, closing the gap with the S&P 500 index’s +7.8% year-to-date gain.

But as you can see in the chart below, the industry has handily outperformed the broader market since early June (blue line represents the banking industry).

Trends in treasury yields have an outsized bearing on bank stocks since they are a big driver of bank margins. You can see this correlation in the year-to-date stock performance of the industry relative to the 10-year treasury yield, with bank stocks moving in-sync with the treasury yield bounce since mid-June.

As important as yields are for banks, we should also be mindful of the group’s successful completion of the Fed’s ‘Stress Tests’ in late-June that allowed many of them to get the central bank’s nod to announce major share buyback and dividend hike programs. One can reasonably argue that with both of these positives now fully discounted, any further gains for bank stocks will follow quarterly results that start coming out on Friday.

My reading of the tea leaves suggests that banks’ Q2 results may turn out to be lot less impressive than what we saw from the group in the preceding reporting cycle. Trends in core profitability drivers weren’t as favorable in Q2 as they were in Q1. These include lower treasury yields (since partly reversed), continued deceleration in loan growth, and an overall trough backdrop for the capital market and advisory businesses.

Estimates for a number of these banks have come down in recent days and weeks to reflect these developments. But I suspect that they haven’t fallen enough to fully reflect the relatively softer ground realities.  

What Are Banks Expected to Report in Q2?

Estimates were going up at this stage in the last earnings season, but they have come down for all the major industry players, including JPMorgan (JPM - Free Report) ,Wells Fargo (WFC - Free Report) and Citigroup (C - Free Report) that will report results at the end of this week.

For the Finance sector as a whole, of which the Major Banks industry is the biggest earnings contributor, total Q2 earnings are expected to be up +5.8% from the same period last year on +2% higher revenues. This would follow +10.5% earnings growth in 2017 Q1 on +5.2% higher revenues.

The table below shows the sector’s Q2 earnings growth expectations at the medium-industry level contrasted with estimates for the following four quarters and actual results for the preceding three periods.

Please note that the Major Banks industry, of which JPMorgan, Wells Fargo and others are part, accounts for roughly 45% of the sector’s total earnings (insurance is the second biggest earnings contributor, accounting for about 25% of the total).

Expectations for Q2

Total Q2 earnings are expected to be up +5.8% from the same period last year on +4.5% higher revenues. This would follow +13.3% earnings growth in 2017 Q1 on +7.0% revenues growth, the highest growth pace in all most two years.

Estimates for Q2 came down as the quarter unfolded, with the current +5.8% growth down from +7.9% at the end of March. The chart below shows how Q2 earnings growth expectations have evolved over the last three months.

Please note that while Q2 estimates have followed a well traversed path that we have been seeing consistently over the last few years, the magnitude of negative revisions compared favorably to other periods. In other words, Q2 estimates have come down, but they haven’t come down by as much.

The table below shows the summary picture for Q2, contrasted with what was actually achieved in Q1.

The chart below shows Q2 earnings growth expectations contrasted with what is expected in the following three quarters and actual results in the preceding 5 quarters. As you can see in the chart below, this growth pace is expected to continue through the rest of the year.

Scorecard for Early Q2 Results

We will start getting June-quarter results this week, with Pepsi’s (PEP - Free Report) report on Tuesday as the first such release. But we have been getting quarterly reports from companies with fiscal quarters ending in May for the last many weeks and all of those reports form part of the Q2 tally as well. In total, we have such Q2 results from 23 S&P 500 members already.

It is hard to draw any firm conclusions from the results thus far, but total earnings for these 23 index members are up +26.1% from the same period last year on +8.3% higher revenues, with 82.6% beating EPS estimates and an equivalent proportion beating revenue estimates.

The table below shows the current Q2 earnings season scorecard.

Note: Here are few key points to keep in mind while reading this report.
   a.  All the earnings analysis in this report pertains to the S&P 500 index, a handy proxy for the entire business world. We use the index’s current membership as the basis for all period comparisons, meaning that even historical periods reflect the index’s current membership.
   b.  We divide the corporate world into 16 sectors compared to the official S&P 10 GICS. We have stand-alone sectors like Autos, Construction, Conglomerates, Aerospace, Transportation and Business Services that provide for a better understanding of trends in these key areas of the economy.
   c.  All references to ‘earnings’ mean ‘total earnings’ and not ‘mean or median EPS’.
  d.  We make adjustments to reported GAAP earnings to account for non-recurring or one-time items, but we do consider employee stock options (ESOs) as a legitimate business expense. Unlike Zacks, Wall Street and all other data vendors don’t treat ESO’s as a recurring business expense.

The chart below shows the weekly calendar of earnings releases for the entire Q2 earnings cycle. As you can see, we are about two weeks away from the reporting cycle really ramping up. We will be getting Q2 results from 37 companies this week, including 8 S&P 500 members.

Here is a list of the 37 companies including 8 S&P 500 members reporting this week.