Breakout

Bank Earnings: More Questions Than Answers About Sector’s Recovery

Breakout

As critical bank earnings keep rolling in, there's been some confusion beneath the headlines. If a bank simply beats earnings estimates, does it warrant a pop in share prices?

This is the reaction we're seeing this morning with Bank of America's (BAC) and Morgan Stanley's (MS) earnings beats. But earlier in the week J.P. Morgan (JPM), Wells Fargo (WFC), and Goldman Sachs (GS) topped expectations, yet traded lower.

All of these big banks, including U.S. Bancorp (USB), reported higher-than-expected revenue growth, while Citigroup's (C) remained flat. While this seems positive, you need to understand what's behind the numbers. As The Wall Street Journal pointed out after JPM and WFC reports, the banks topped revenue estimates mostly because they scaled down future loan loss coverage.

Nonetheless, some degree of confidence has pushed bank stocks to lead the 2012 rally. The Financial Sector SPDR (XLF) is up 18% year-to-date versus the S&P 500's 10% rise.

"The (bank) earnings justify the move that we've seen so far," says Jack Ablin, chief investment officer at Harris Private Bank. "I think we're able to hold the values that we've got. So now the question is looking forward: 'Are the favorable trends going to continue?'"

Ablin is less focused on headwinds because they mostly revolve around politics. Dodd-Frank reform is being fiercely fought by Republicans and isn't likely to move forward before the November election. A potential to run into the debt ceiling does exist, but like financial reform, it'll likely be punted out to 2013 through a short-term extension.

So right now gridlock is a net positive for the banks. Now on to the other potential tailwinds.

Ablin points to improvement in commercial industrial loan growth and a steeper yield curve as catalysts for a real banking recovery.

"From a macro perspective, generally the stock prices move in tandem with interest rates," he says. "What we find is right now there's a gap between the move we see in stock prices and 10-year treasury rates remaining pretty low."

Long rates should push higher if the economy continues to improve, which is why Ablin is watching the 10-year yield so closely. If it's above 2.5% at the end of the year, it'll be great for the banks, but below 2% --where we are right now-- could give way to a pullback, in his view.

All of which leads to the Federal Reserve and their impact on the banks. If the Fed has enough confidence in the economy and doesn't implement more quantitative easing, rates will rise and clear the path toward a positive environment for bank profits. But as transparent as the Fed claims to be, their next move is about as clear as Warren Buffett's succession plan.

So far, bank earnings are raising plenty of questions and yielding few answers about the road ahead.

Do you think the banks will hold on to this year's gains? Are you ready to call a full recovery for the big banks? Let us know in the comment section below, or visit us on Facebook.

Rates

View Comments (79)