Bank stocks enthusiastically participated in the post-Christmas rally, but they lost steam in mid-March as Treasury yields pulled back again and have recovered only about half of losses since then. The chart below shows the 6-month stock market performance of the Zacks Major Banks industry, which includes the space's leading players, relative to the S&P 500 index.
JPMorgan (JPM) and Wells Fargo (WFC) kick-off the Q1 earnings season for the group on Friday, April 12th, with a host of industry players following suit the following week. In all, we will get Q4 results from more than 20 companies this week, including 6 S&P 500 members.
The question is whether these quarterly results can serve as a catalyst for bank stocks?
To answer that question, we need to keep in mind that the issue with these stocks has not been a lack of operating performance, but rather big-picture uncertainty. On most key operating metrics, bank performance was been very strong in recent quarters and we will most likely see a repeat performance this earnings season as well.
Key parts of the market's worry list for banks include the flattening yield curve and potential for inversion that has implications for the economy's health beyond 2019. The recent change in the Fed's monetary policy stance is essentially an acknowledgment of the same late-cycle narrative.
Keep in mind that banks are cyclical businesses engaged in lending and other activities like investment banking, money management, and trading that are always at the mercy of the economic cycle. Banks not only experience low demand for its services when the economic cycle turns down, but the quality of its existing assets (its loan portfolio) also goes down as its customers' credit profiles weaken.
Even if we keep aside the market's other worries like trade uncertainty, global growth and political issues, it is this late-cycle worry that has been the big weight on sentiment on bank stocks. That said, it is reasonable to expect that with valuations this compressed already, strong results will give many of these stocks a short-term bump. But a fundamental rerating may be not be possible till the big-picture worries are put to rest.
What Are Banks Expected to Earn?
Total Q1 earnings for the Zacks Major Banks industry that includes JPMorgan, Wells Fargo and other major industry players are expected to be down -6.5% from the same period last year on -0.8% lower revenues. The decline is primarily a function of tough comparisons, with the year-earlier tally reflecting one-time boost from the tax cut legislation.
For the Finance sector as a whole (Major Banks industry brings in roughly 45% of the sector's total earnings), total Q1 earnings are expected to be barely in positive territory; up +0.5% on +6.4% higher revenues. The chart below puts the Finance sector's Q1 earnings and revenue growth expectations in the context of where growth has been and where it is expected in the coming periods.
The table below presents the Finance sector earnings picture at the medium industry level.
The 'Earnings Recession' Narrative
With earnings growth expectations for the first quarter of 2019 already in negative territory and estimates for 2019 Q2 moving in that direction as well, there is growing talk of an impending earnings recession.
This is coming at a time when many in the market are worried about the duration of the current economic cycle that is on track to become the longest in the nation's history later this summer. It is this backdrop that has made market participants overly sensitive to the shape of the Treasury yield curve and its cyclical implications. No doubt, the 'R' word has become potent.
So how reasonable are these 'earnings recession' fears?
The definition of 'recession' is two or more quarters of negative growth, typically GDP growth. The chart below of quarterly year-over-year earnings growth for the S&P 500 index shows estimates for the current and following three quarters and actual results for the preceding 5 quarters.
To be totally pedantic about it, the recession talk reflects ground reality, as you can see in the chart above. After all, earnings growth in the first two quarters of the year is on track to be negative, even though the 2019 Q2 growth pace is barely in negative territory.
We shouldn't take this recession talk too seriously, however. The reason is that the negative growth in the first half of the year is solely because of very tough comparisons. In other words, the base period for 2019 Q1 growth is 2018 Q1, when earnings received a huge boost from the tax-cut legislation. The lower corporate tax rates that showed up in earnings for the first time in 2018 Q1, the base year for 2019 Q1, boosted profitability through margin expansion. As such, we are up against some tough comparisons in 2019.
The tax cut legislation didn't have a direct bearing on revenues last year and we are not seeing that much drop off in estimates for this year either, as the chart below shows (orange bars).
So, if the earnings recession is only 'technical', is there nothing to worry about on the earnings front?
That's not correct as there are legitimate reasons to be wary of the earnings picture. The earnings growth trajectory would be challenged and difficult even without the issue of the aforementioned tough comparisons as the global economic growth backdrop has become less favorable and cyclical rises in transportation, logistics, payroll and other expenses are squeezing margins. As a result, analysts steadily lowered their estimates for 2019 Q1 as well as full-year 2019, as you can see in the chart below.
The weak guidance from Nike, FedEx (FDX), Walgreen's (WBA) and others in this reporting cycle suggests that we will likely see a replay of what we experienced the las t earnings season that pushed estimates lower. We will be keeping a close eye on how estimates for 2018 Q2 evolve as companies report Q1 results and share their outlook for Q2 and beyond.
Expectations for 2019 Q1 & the Initial Earnings Report
Total earnings for the S&P 500 index are expected to be down -4% from the same period last year on +4.6% higher revenues. If actual 2019 Q1 earnings growth turns out to be negative, it will be the first earnings decline since the second quarter of 2016.
Driving the expected Q1 earnings decline is broad-based margin pressures across all major sectors, with net margins for the index of 11% down from 12% in the year-earlier and 11.8% in the preceding quarter. The Utilities sector is the only one that is expected to have unchanged net margins in 2019 Q1 relative to the year-earlier period, with margins expected to be lower for all of the remaining 15 sectors.
Q1 earnings growth is expected to be negative for 9 of the 16 Zacks sectors, with double-digit earnings declines for 5 sectors, including Energy and Technology. For the Technology sector, Q1 earnings are expected to be down -10% from the same period last year on +3% higher revenues and 270 basis points compression in net margins.
The table below shows the summary picture for 2019 Q1, contrasted with what was actually achieved in the preceding period.
Q1 Scorecard ( as of Friday, April 5th, 2019 )
The market will start paying attention to the start of the earnings season following the quarterly reports from JPMorgan and Wells Fargo on April 12th. But these bank earnings reports will not be the first of the Q1 earnings season, as the reporting cycle has actually gotten underway already, with results from 23 S&P 500 members out. All of these early reports, which includes a few bellwethers like FedEx (FDX), Nike (NKE) and others, have fiscal quarters ending in February, which we count as part of our March-quarter tally.
For the 23 S&P 500 members that have reported Q1 results already, total earnings are down -10.8% from the same period last year on +4.2% higher revenues, with 73.9% beating EPS estimates and 52.2% beating revenue estimates.
The Q1 growth for these 23 index is tracking notably below what we had seen in the recent past and positive revenue surprises appear also to be on the weak side, as the comparison charts below show.
It is premature to draw any firm conclusions from this admittedly small sample of Q1 results, but it is nevertheless a weak start to the reporting season.
For an in-depth look at the overall earnings picture and expectations for Q1, please check out our weekly Earnings Trends report >>>>Is the Earnings Picture Really Weak?
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