Drop In Bank Stocks Is Understandable, But A Bounce Will Follow

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I have said it many times before and undoubtedly will do so many times in the future, but the market cannot be “wrong.” A market price simply represents the last place a buyer and seller agreed to transact. The price is therefore inherently correct, but that doesn’t always mean that the decision-making process of traders and investors is perfect.

Sometimes, largely as the product of a prevailing sentiment, information is analyzed with a collective confirmation bias that focuses on one thing and forgets or ignores others. That is what seems to have happened to bank stocks on Friday.

Three major banks, Citigroup (C), JP Morgan Chase (JPM) and Wells Fargo (WFC) released earnings on Friday morning. In all cases the results were good, with significant earnings beats, yet all three stocks got hammered. That morning, I wrote a piece that detailed the three most common reasons that happens. Friday’s reaction to earnings in bank stocks falls under the second heading of “A Miss Elsewhere.”

The earnings of big, diverse banks such as the three that released Friday are extremely complicated. They have multiple revenue sources and some complex regulatory and reporting requirements that make reacting on your first impression of headline numbers dangerous. There are many things that can either disappoint or delight traders hidden deep in the numbers and this time the disappointment reportedly came in weaker than expected loan generation numbers.

There is no doubt that loan generation was disappointing, and that it is potentially a problem with implications beyond the banking sector. If neither consumers nor businesses are taking out loans at the expected rate, that has seemingly obvious negative consequences for growth, the foundation on which all market optimism is built.

This is nothing new, though. Even as banking profits elsewhere have grown over the last few years, their traditional lending business has lagged.

What strikes me about Friday’s action is that the market seemed to accept that as a problem at face value, without asking themselves why loan growth has remained disappointing for that long.

The assumption contained in the negativity is that it indicates a lack of personal and corporate investment in the future, and therefore a lack of confidence in the economy. The trouble is, metrics that measure those things are suggesting the complete opposite.

As you can see, while both consumer confidence and business sentiment declined slightly in the latest data, that came in the context of a strong and persistent rise to the highest levels in a decade. So, if consumers and businesses feel good about the economy, why aren’t they borrowing?

The answer is because they don’t have to.

The recession of 2008/2009 had some devastating effects on many people and businesses, but even those that survived were left scarred. There is nothing like a global credit crunch to impress on people the dangers of debt and the value of liquidity. Households and businesses have spent the last decade deleveraging and stashing cash so as not to be caught when and if a squeeze on credit once again rears its ugly head.

Since around 2010 or 2011, when it was evident that the recovery was real and continuing we have heard about this frequently, particularly on the corporate front. Whether the information is couched as a simple observation or as an accusation, we have all heard many times that corporate America has amassed massive amounts of cash during the recovery. When things start to look up, is it any wonder that rather than rushing out and repeating the mistakes of the 2000s, corporations and household alike simply begin to spend down their “savings”?

So, when placed in an historical context, the failure of loan generation at the big banks to grow as expected has very few or no implications for broad economic growth. At this point in the cycle it is still possible for both consumers and businesses to invest in their future in a less debt-dependent manner than we have come to expect, and that must be a good thing. It makes a repeat of 2007/8 far less likely and forms a solid base for future growth.

For the bank stocks themselves, it is also good news. Loan generation may be the traditional business of banks, but it is not where the majority of their profits originate these days. Trading, wealth management and other areas more akin to the business of the finance houses of old than traditional banks is where the big bucks are, and those are the areas that drove the widely ignored revenue earnings beats.

In the context of the negative market sentiment that prevailed on Friday due to geopolitical and domestic political risks, a negative reaction to the partial miss in bank earnings is understandable. However, in the more positive sentiment that looks like dominating this week after targeted strikes in Syria did not spark WW3 and Michael Cohen has survived the weekend as a free man without spilling his guts, it will look mistaken.

That makes C, WFC and JPM likely to lead a market bounce from here, at least in the short term, and therefore worth buying on the drop.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Earnings , Investing Ideas , Stocks , US Markets
Referenced Symbols: C , JPM , WFC

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Martin Tillier

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