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Big banks set aside $4 billion for a recession. Investors are more optimistic: Morning Brief

This article first appeared in the Morning Brief. Get the Morning Brief sent directly to your inbox by signing up here.

Saturday, January 14, 2022

Today's newsletter is by Myles Udland, Head of News at Yahoo Finance. Follow him on Twitter @MylesUdland and on LinkedIn. Read this and more market news on the go with Yahoo Finance App.

Big banks including JPMorgan, Wells Fargo, Citigroup, and Bank of America all reported quarterly results on Friday.

These firms collectively sent a clear message to investors — we are preparing for a downturn.

As a group, these banks set aside more than $4 billion in loan-loss provisions, or money they expect won't be paid back by borrowers.

JPMorgan (JPM) set aside $1.85 billion in provisions for credit losses, saying these reserves were built as the firm's outlook is "now reflecting a mild recession in the central case."

Bank of America (BAC), for its part, set aside $1.1 billion for credit losses in the fourth quarter, Wells Fargo (WFC) $936 million, and Citigroup (C) another $640 million.

Initially, investors saw these reserve builds as a negative sign for banks and the economy more broadly. Futures were lower early Friday, as were shares of each bank.

By the time the closing bell rang on Friday, however, shares of each company were higher along with the broader market.

A reaction from investors that is consistent with early trading in 2023.

And perhaps indicative of a more constructive backdrop in the months to come.

JPMorgan Chase & Co President and CEO Jamie Dimon attends a U.S. House Financial Services Committee hearing titled “Holding Megabanks Accountable: Oversight of America’s Largest Consumer Facing Banks” on Capitol Hill in Washington, U.S., September 21, 2022. REUTERS/Elizabeth Frantz
JPMorgan Chase & Co President and CEO Jamie Dimon attends a U.S. House Financial Services Committee hearing titled “Holding Megabanks Accountable: Oversight of America’s Largest Consumer Facing Banks” on Capitol Hill in Washington, U.S., September 21, 2022. REUTERS/Elizabeth Frantz (Elizabeth Frantz / reuters)

In a note to clients earlier this week, Fundstrat's Tom Lee observed that market history says the S&P 500's rally in the first few days of the year — a period that wrapped up last Tuesday — is an unequivocal positive.

Citing the "First Five Days" rule, Lee notes that in seven prior instances in which the S&P 500 rose 1.4% or more in the first five trading days of the year after a losing year, the index logged annual gains each time — with an average gain of 26%.

"In other words, the 'base' case for 2023 is [the] S&P 500 could gain >25%," Lee wrote. "And this is completely counter to consensus which sees [the S&P 500] falling to 3,000 in first half 2023, before recovering to be flat. In short, 2023 should see far stronger returns than many expect."

Now, a rebound in the stock market after traders endured the most challenging environment in a generation should come as only a mild surprise. The stock market may not be mean reverting, but stocks do tend to go up over time.

Moreover, investors tend not to react to what is happening but rather what they think will happen.

Apply this logic to the case of bank stocks on Friday, and the market action suggests investors feared even worse news. If some investors think this is a "bad news is bad news" kind of market, then it seems the inverse is true as well — good news was good news on Friday.

And if we look away from financial giants and towards more speculative pockets of the market, we find that risk-on energy is definitely percolating beneath the surface.

Frantic rallies in one-time meme stocks like Bed Bath & Beyond (BBBY) and Carvana (CVNA) this week — and to a lesser extent names like Coinbase (COIN) and Cathie Wood's flagship ARK Innovation ETF (ARKK) — suggest some investors have entered 2023 with a "new year, new you" mindset after a rough 2022.

And whether you consider yourself a market historian or not, anyone paying even cursory attention to daily price action in early 2023 can see things look quite different from how we ended last year.

Now, the rub in noting stocks go up over time is that the impulse behind these steady gains are steadily rising corporate profits. And many on Wall Street still don't think investors are being conservative enough in modeling a drop in profits this year.

But if stock prices tell us what investors believe about the future, then corporate profits tell us what we know about the past.

In the fourth quarter of 2021, JPMorgan, Bank of America, and Citigroup, for instance, all released reserves that had been set aside for credit losses amid a booming economy and healthy consumer balance sheets. In the year that followed, inflation surged to 40-year highs, and an imminent recession became the consensus view on Wall Street and Main Street.

Against this recent history, then, Friday's market reaction serves as a reminder investors already prepped for this bad news from banks. That's what all the fuss was about last year.

And what all the optimism is about so far this year.

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