Earnings Outlook: Will Earnings Jumpstart Regional Banks?

Summary

• Major bank earnings show there is little to worry about them. But regional banks continue to trade near March lows as earnings loom this week.
• The Russell 2000 index is also trading near March lows, as investors fear a potential credit crunch at smaller banks.
• Yet the large cap S&P 500 and NASDAQ 100 indices are flirting with 2023 highs, largely on hopes of rate cuts later this year.
• We continue seeing risks tilted to the downside if earnings, outlooks, or the Federal Reserve (Fed) disappoint.
• Q1 earnings begins in earnest, with more than 80 companies slated to report. About a dozen regional banks will deliver reports and outlooks. Expect a mixed bag.

What We Learned Last Week

Equity investors face two major questions as Q1 earnings season opens: Whither banks? And is the ongoing equity rally for real?

Major banks are OK: JP Morgan Chase (JPM) and Citigroup (C), and to a lesser extent Wells Fargo (WFC), laid to rest concerns that the crisis since Silicon Valley Bank (SVB)’s collapse was an issue for them (Chart 1). JPM and C rallied sharply after posting solid earnings beats and reassuring outlooks for 2023. JPM’s CEO, Jamie Dimon, has warned of recession risks, but that did not seem to weigh on JPM’s business prospects as the bank boosted loan loss reserves only slightly. Dimon also said he expects higher rates for longer – leading JPM to increase its net interest margin forecast for 2023 by 11% to $81bn.

Regionals struggle: The regional bank ETF, KRE, was down 1.9% on its major bank cousins’ good fortune. A big factor in the decline was probably that major banks gained deposits during the banking crisis, at the expense of smaller banks. We will get the regional bank spin on the SVB crisis next week. For now we view RTY as a canary in the coal mine. We added major banks to our model portfolio in late March, but remain cautious about regional banks.

It Is All About Rate Cuts

Turning to equities, a similar divide exists between large cap indices (S&P 500 (SPX) and NASDAQ 100 (NDX)) and the small cap Russell 2000 (RTY) (Chart 2). SPX and NDX have rallied well above pre-SVB levels, while RTY is trading near post-SVB lows.

The key factor is that the smaller companies in the RTY are critically dependent on smaller banks for financing. With deposits apparently flowing to larger banks or money market funds, a credit crunch is a real possibility. Given that nearly half of Americans are employed by small businesses, this is a potential headwind for the economy.

Yet the S&P and NDX keep pushing higher. We see two reasons for this.

• Earnings so far are solid, and outlooks are generally good, with only a few mentions of recession risks. There has been little reason to sell due to bearish forecasts.
• Jamie Dimon’s rate view notwithstanding, markets seem incredibly confident that the Fed will cut rates later this year. 

We note that higher equity valuations are almost entirely due to prospects of lower rates and a lower discount rate on earnings – we see little indication that earnings are on the cusp of a significant upturn.

So, equities are balanced between the upside of lower rates – and the downside of potentially weak banks and a more hawkish-than-expected Fed. We continue to see risks tilted to the downside.

The Week Ahead

Q1 earnings season heads for the races, with more than 80 companies scheduled to report. Regional banks will be reporting throughout the week. We caution that many of the headliners are relatively large and included in the S&P 500. Their performance and outlooks may benefit them individually but may shed little light on the prospects for the thousands of smaller banks out there. Among the highlights:

Monday

• M&T Bank Corporation (MYB), with roots in the rustbelt northeast, leads off regional bank week.
• JP Hunt Transport Services (JBHT) outlook for rail and truck shipping volumes will detail prospective demand for industrial and consumer goods.

Tuesday

• Bank of America (BAC) and Goldman Sachs (GS) will add to the major bank cheer.
• Everyone will be waiting for Netflix (NFLX) to report on progress in wringing revenue out of viewers who piggy-back on paying subscriber accounts.
• United Airlines (UAL) (and Alaska Airlines (ALK) on Thursday) will likely report solid bookings for summer travel.

Wednesday

• Tesla (TSLA) may indicate whether rising sales volumes are offsetting the impact of price cuts.
• Aluminium producer Alcoa (AA) will help define the outlook for global and US industrial activity.
• Will weakening construction activity derail Steel Dynamics (STLD)’s previous bullish outlook for steel demand in 2023?

Thursday

• This is the big regional bank day, as Bank Ozk (OZK), Comerica (CMA), Fifth Third Bancorp (FITB), Huntington Bancorp (HBAN), Keycorp (KEY), and Synovus Financial (SNV) all report.
• CSX Corporation (CSX) and Union Pacific Corporation (UNP) add to the general outlook on shipping demand across the country.
• Is ManpowerGroup (MAN) finding it easier to fill positions? If so, is that because of softer demand for labour or more people willing to work?

Friday

• Regions Financial (RF) rounds out a busy week for regional banks.
• Procter and Gamble may give more colour about how consumer demand for brand name products is faring.

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

Photo Credit: depositphotos.com

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