Bank Earnings Provide A Positive Start To Earnings Season Despite The Misses

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Earnings season began in earnest last week with 17 S&P 500 companies reporting, with banks and financials dominating the total. The S&P 500 fell by almost 1% for the week but recovered from being down 4.5% at one point. Bank earnings helped lift the market, with bank shares about 1% higher last week. The pace and the breadth of the first-quarter earnings season increase this week, with 72 S&P 500 scheduled to report. Only 7% of S&P 500 companies have reported results so far, with 60% exceeding consensus earnings and sales estimates, respectively.

At this early juncture, blended earnings, which combine actual with estimates of companies yet to report, are only slightly higher than forecasts at the end of the quarter and actually fell last week. The high earnings growth rate for the industrials is a bit misleading this quarter since the airlines reported a loss in the second quarter of 2021 and should post a profit this quarter. Only three sectors, including energy, health care, and consumer staples, are expected to post higher earnings than expected on June 30th. The energy sector has benefited from increased energy prices, with expected earnings rising again last week and slated to increase by 255% year-over-year. On a related note, regulatory filings showed that Berkshire Hathaway continued to buy shares of Occidental Petroleum
(OXY) last week and now owns over 19% of the company. A previous piece discussed why Warren Buffett’s Berkshire Hathaway
could be adding to its stake in Occidental Petroleum.

The blended revenues paint a similar picture, with only the same three sectors having better estimates now than at the end of the quarter. Sales in the energy and materials sectors illustrate the robust increase in commodity prices. The only S&P 500 sector with stock price gains year-to-date is energy.

So far, the blended earnings performance has slightly exceeded expectations at the end of the quarter. Combining actual results with consensus estimates for companies yet to report, the blended earnings growth rate for the quarter eased to 4.2% year-over-year but still slightly above the expectation of 4.1% at the end of the quarter. Expected earnings growth for calendar year 2022 and 2023 declined slightly this week.

Bank and financial earnings dominated the first week of the earnings season. Headline earnings from the banks were a mixed bag. JPMorgan (JPM), Morgan Stanley
(MS), US Bancorp
(USB), and Wells Fargo
(WFC) fell short of estimates while First Republic (FRC), PNC (PNC), and Citigroup
(C) beat. Overall the headline bank earnings were worse than expected, leading to a deterioration in the blended earnings growth rate for the financial sector. Then why did banks rally last week? As previewed last week, headline earnings were bound to be disappointing due to increased loan loss reserve, but core earnings from lending have benefitted from rising interest rates. Net interest margin (NIM), the spread a bank earned in interest on loans compared to the amount it paid in interest on deposits, has improved across every bank so far. Loan balances were higher for the group, so when combined with better net interest income drove better net interest income (NII). Additionally, while the banks are preparing for future possible loan losses by increasing reserves, actual delinquencies and credit trends have remained benign so far and, according to JP Morgan, better than pre-Covid. The bear market in stocks negatively impacted capital markets-related earnings, but the core lending business of the banks remains healthy. More banks and financials report this week, including Bank of America
(BAC), Schwab (SCHW), Goldman Sachs (GS), American Express
(AXP), and several regional banks.

Banks benefited from the rising tide in yields until early March, when the relative performance of bank stocks and the path of interest rates diverged. The market began to price in a very aggressive rate hike path from the Federal Reserve to combat inflation, raising the probability of a future recession and more than offsetting the tailwind banks were getting from improved net interest margin based on higher yields. Bank shares seem likely to remain in the tug of war between the current benefits to profitability from the rate hikes and a future possible economic downturn that will cause increased loan losses. On a more positive note, some banks look reasonably priced and can rally sharply when news is better than expected, like Citigroup, which rose 13% on Friday.

While it is still very early, headline earnings have eked out only a small outperformance versus estimates. Much of the earnings weakness for the index can be blamed on the loan loss reserve building at the banks since the estimated year-over-year earnings growth for the S&P 500 is 11.2% if financials are excluded, according to FactSet. While increased cost pressures have weakened overall demand, some companies, like PepsiCo (PEP), have still managed to pass along price increases and grow earnings despite the headwinds. This week a more diverse group of companies outside of primarily financials reports earnings, so it will be instructive to see if the earnings performance improves. Outside of the earnings season, market participants will be looking for clues about the size of the interest rate hike at the July 27th meeting following the 9.1% year-over-year record high in consumer inflation (CPI) reported last week. The market has currently priced in an upcoming hike of 75 basis points (0.75%). Still, the hot headline inflation reading, which had ugly underlying details, also leaves a non-trivial chance that the Federal Reserve will escalate to a full percentage point increase in rates.


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