Earnings season has kicked off. Historically, bank stocks are among the first to report. J.P. Morgan Chase (NYSE:JPM), as expected, delivered stellar results. Wells Fargo (NYSE:WFC) came in with mixed results that were still in line with expectations. But Goldman Sachs (NYSE:GS) was a miss. Bank of America is expected to report solid earnings on October 16.
But the question for many investors is what does any of this mean? This is one time when investors need to look beyond conventional wisdom.
The outlook for bank stocks
Bank stocks still have an attractive valuation that should serve as a tailwind moving forward. The banking index is estimated to trade at a multiple of 10.2 times earnings for the next 12 months. This is in comparison to the broader S&P 500’s recent trading multiple of 16.4.
Bank stocks tend to serve as a barometer for earnings season. If the bank stocks perform well, it portends solid earnings for corporations. This is because when banks are doing well, it means that consumer and business lending is strong. As much as it’s important for consumers to save, our economy is fueled by their ability – and willingness – to take on debt.
And with the economy showing signs of weakening at the edges, consumer confidence has remained strong. That’s why there was anxiety surrounding this quarter’s earnings reports. When the Federal Reserve began lowering interest rates in July, the assumption was that it would put a significant amount of downward pressure on the bank’s revenue. But if J.P. Morgan’s results are any indication, the big banks may be healthier than originally thought.
The big banks appear to be well-positioned
J.P. Morgan beat on both the top and bottom lines. Actual revenue came in at $29.34 billion which beat analysts’ expectations by nearly one billion dollars. Earnings per share (EPS) came in at $2.68 which was also well ahead of expectations for a $2.45 price per share.
One reason for the success of the big banks is their capital structure. “The bigger banks have a much deeper capital market structure that they can leverage for revenue than the regional banks don’t have,” said Chris Hempstead, top ETF consultant and former head of ETF sales at Deutsche Bank.
This outlook fits with the analysis from John Hancock. At the end of August, the financial service firm gave their opinion that bank fundamentals remained strong. They went further to say that they had an expectation that the banking industry would post earnings growth in the mid- to high-single digits for the rest of 2019 as well as 2020.
Furthermore, Mortgage Bankers Association data suggests that banks may get some support from strength in mortgage banking. Refinancing applications have more than doubled on a year-over-year basis. Refinancing makes up more than half of all mortgage applications. Manulife Investment Management’s Lisa Welch, who manages the John Hancock Regional Bank Fund, said that “with rates being lower, we think mortgage activity will be very strong.”
The case is more muddled for regional banks
However, the outlook for regional banks is more difficult. Citigroup warned investors that the market may not be pricing in the full impact of lower interest rates on the regional banks.
“Macro headwinds from lower rates present a large challenge for the regional banks,” said analyst Keith Horowitz. “The recent move down in rates is not being fully priced in.”
Of course, some regional banks are in a better position than others. One way to successfully play regional banks during this earnings season is through an exchange-traded fund (ETF) that focuses on larger regional banks. Todd Rosenblush, senior director of ETF and mutual fund research at CFRA, suggests investors look at the iShares Regional Bank ETF (IAT). The IAT has five bank stocks that account for approximately half of its market-weighted portfolio. This is in contrast to the SPDR S&P Regional Banking ETF (KRE) which is an equal-weighted fund.
“It’s (large banks) not as dependent upon loans and loan growth,” said Rosenbluth, “but broader areas of revenue that you’re going to have: asset management, wealth management, trading, and capital markets. That diversification is going to help in a lower-for-longer interest rate environment.” Rosenbluth went on to say, “It highlights how important it is to look inside the portfolio,” and that investors can find a “big difference in the number of holdings, big difference in the size of those holdings and (in) the position – so roughly 2 or 3% of the assets in those large regional banks (in KRE) as opposed to 8 or 9%”
Companies Mentioned in This Article
|JPMorgan Chase & Co. (JPM)||$130.18||-0.3%||2.77%||14.46||Hold||$122.77|
|Wells Fargo & Co (WFC)||$53.73||-0.6%||3.80%||12.27||Hold||$50.21|
|Goldman Sachs Group (GS)||$218.71||-0.6%||2.29%||8.65||Hold||$246.36|
|Bank of America (BAC)||$32.80||-0.4%||2.20%||12.57||Hold||$33.13|